Vandalay Industries, Inc. has been a takeover target for a while due to its rece
ID: 2799739 • Letter: V
Question
Vandalay Industries, Inc. has been a takeover target for a while due to its recent tremendous rate of growth. The company has reported this year's earnings of $132 million and it has 8.25 million shares outstanding. It also declared that its per share dividend this year will be $2 for the next six years. Stock analysts predict that the firm's EPS will grow by 12% annually They also estimate that the company's stock beta is 3.5 and the mean PE ratio of all other firms in the industry is 8. In addition, during this year the yield on a newly issued 1-year Tbill has been 2% and S&P500; stock index increased from 2,500 to 2,600 points. Based on the above information, answer the following questions 1. At what price will the company's shares be expected to trade in six years and at what price should they be expected to trade today according to the adjusted dividend discount model? (10 points)Explanation / Answer
Using CAPM, Required Return, r = Rf + beta x (Rm - Rf)
Rf - Risk-free = 2%, beta = 3.5, Rm - Market Return = 2600 / 2500 - 1 = 4%
=> r = 2% + 3.5 x (4% - 2%) = 9%
Current EPS = Earnings / No. of shares = 132 / 8.25 = $16.0
In six years, EPS = 16 x (1 + 12%)^6 = $31.58
Price in six years, P6 = EPS x P/E = 31.58 x 8 = $252.65
Price today, P0 = D / (1 + r) + D / (1 + r)^2 + ... + (D + P6) / (1 + r)^6
= 2/1.09 + 2/1.09^2 + ...(252.65 + 2)/1.09^6
= $159.62
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