Janet Ludlow\'s firm requires all its analysts to use a two-stage DDM and the CA

Question

Janet Ludlow's firm requires all its analysts to use a two-stage DDM and the CAPM to value stocks. Using these measures, Ludlow has valued QuickBrush Company at $63 per share. She now must value SmileWhite Corporation. a. Calculate the required rate of return for SmileWhite using the information in the following table December 2010 Brush Bcta Market Price Intrinsic Value SmileWhite 1.25 $30 1.35 $63.00 Note: Risk-free rate = 4%; expected market return = 15.5%. Instruction: enter your answer as a percentage rounded to 1 decimal place. Required rate of return b. Ludlow estimates the following EPS and dividend growth rate for SmileWhite: First three yo rs: Years thereafter: 15% 12% Estimate the intrinsic value of SmileWhite in December 2010 using the table above and the two-stage DDM. Dividends per share in 2010 were $1 Instruction: enter your answer as a decimal number rounded to 2 decimal places Year Dividends 2010 $1.00 2011 S 2012 S 2013 2014 S Intrinsic stock value in 2013: S Intrinsic stock value in 2010: S

Explanation / Answer

expected return = risk free rate + beta * (market return - risk free rate)

a)

required rate of return = 4% + 1.25 * (15.5% - 4%)

= 18.375%

= 18.4%

b)

Dn = D0 * (1+g)^n

=>

D(2011) = 1 * (1+15%) = 1.15

D(2012) = 1 * (1+15%)^2 = 1.32

D(2013) = 1 * (1+15%)^3 = 1.52

D(2014) = 1 * (1+15%)^3 * (1+12%) = 1.70

price = dividend next year /(required rate of return - growth rate)

intrinsic value in 2013 = 1.7/(0.184 - 0.12) = 26.56

PV of dividends in 2010 = 1.15/1.184 + 1.15^2/1.184^2 + 1.15^3/1.184^3

= 2.83

intrinsic value on 2010 = PV of dividends + PV of intrinsic value in 2013

= 2.83 + 26.56/1.184^3

= 18.83

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