Question

Assume there are three companies that in the past year paid exactly the same annual dividend of $1.28 a share. In addition, the future annual rate of growth in dividends for each of the three companies has been estimated as follows: SEE TABLE. Assume also that as the result of a strange set of circumstances, these three companies all have the same required rate of return (r=12).

Buggies- Are-Us	Steady Freddie, Inc	Gang Buster Group
g = 0	g = 8%	Year 1	$1.44
(i.e. dividends are expected to remain at $1.28/share	(for the foreseeable future)	2	$1.62
		3	$1.82
		4	$2.05
		Year 5 and beyond: g = 8%

a. Use the appropriate DVM to value each of these companies.

b. Comment briefly on the comparative values of these three companies. What is the major cause of the differences among these three valuations?

For Buggies-Are-Us, the value of the company's common shares is _______ (Round to the nearest cent.)

For Steady Freddie, Inc., the value of the company's common shares is ______(Round to the nearest cent.)

For Gang Buster Group, the value of the company's common shares is _______ (Round to the nearest cent.)

Answer 1

Buggies are-US: The appropriate DVM method to use is single DVM method with no growth.

Price of stock= D/R = 1.28/0.12 = 10.66

Steady Freddie:

The appropriate DVM method to use is single DVM method with constant growth (gordon growth model)

Price of stock= D/R = (1.28*1.08)/(0.12-0.08) = 1.3824/0.04 = 34.56

Gang Buster Group:

The appropriate DVM method to use is multistage DVM method with constant growth after 4 years

Price of stock= D1/1.12 + D2/(1.12)² + D3/(1.12)³ + D4/(1.12)⁴ + (D4*1.08)/ (0.12-0.08)*(1.12)⁴

^{= 1.285714+ 1.291454 + 1.29544 + 1.302812 + 35.175926= 40.076654}

^{tHE major cause of difference in the value of three stocks is the dividend policy of the respective companies. when the company pays a constant dividend each year it impacts its value, investors lose confidence. But when dividend keeps on improving year on year with som long term growth rate after few years, it brings profitability to business.}