Assume you\'ve generated the following information about the stock of Bufford\'s

Question

Assume you've generated the following information about the stock of Bufford's Burger Barns The company's latest dividends of $4 41 share are expected to grow to $4 81 next year, to $5 24 the year after that, and to $5 71 m year 3 In addition, the pnee of the stock is expected to nse from $72 69 (its current price) to $103 73 in 3 years a. Use the dividends-and-eamtngs model and a required return of 15% to find the value of the stock b. Use the 1RR procedure to find the stock's expected return c. Given that dividends are expected to grow indefinitely at 9%, use a 15% required rate of return and the dividend valuation model to find the value of the stock d. Assume dividends in year 3 actually amount to $5 71, the dividend growth rate stays at 9%. and the reqiwed rate of return stays at 15% Use the dividend valuation model to find the pnee of the stock at the end of year 3

Explanation / Answer

a.

Value of stock is the present value of future cash flows i.e. future dividends and expected share value.

Year

Cash flow

Present value factor @ 15%

Present value of cash flows

1

Dividend

$ 4.81

0.8696

$ 4.18

2

Dividend

$ 5.24

0.7561

$ 3.96

3

Dividend

$ 5.71

0.6575

$ 3.75

3

Stock price

$ 103.73

0.6575

$ 68.20

$ 80.10

Value of stock = $80.10.

b.

At IRR, present value of future cash flows must be equal to the current value of share.

Hence,

$72.69 = $4.81/(1+r) + $5.24/(1+r)2 + $5.71/(1+r)3 + $103.73/(1+r)3

Solving above equation, we get r= 0.18998 = 19%

Hence, IRR = 19%

c.

Value of stock = Dividend at year 1/(Required rate – Growth rate) = $4.81/(0.15-0.09) = $80.17

d.

Price of stock at the end of year 3 = Dividend at year 4/(required rate – growth rate) = $5.71(1+0.09)/(0.15-0.09) = $6.22/0.06 = $103.67

Year

Cash flow

Present value factor @ 15%

Present value of cash flows

1

Dividend

$ 4.81

0.8696

$ 4.18

2

Dividend

$ 5.24

0.7561

$ 3.96

3

Dividend

$ 5.71

0.6575

$ 3.75

3

Stock price

$ 103.73

0.6575

$ 68.20

$ 80.10

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