Question #81
Reading: Reading 20 Discounted Dividend Valuation
PDF File: Reading 20 Discounted Dividend Valuation.pdf
Page: 31
Status: Unattempted
Question
An analyst for a small European investment bank is interested in valuing stocks by calculating the present value of its future dividends. He has compiled the following financial data for Ski, Inc.: Earnings per Share (EPS) Year 0 $4.00 Year 1 $6.00 Year 2 $9.00 Year 3 $13.50 Note: Shareholders of Ski, Inc., require a 20% return on their investment in the high growth stage compared to 12% in the stable growth stage. The dividend payout ratio of Ski, Inc., is expected to be 40% for the next three years. After year 3, the dividend payout ratio is expected to increase to 80% and the expected earnings growth will be 2%. Using the information contained in the table, what is the value of Ski, Inc.'s, stock?
Answer Choices:
A. $71.38
B. $39.50
C. $43.04
Explanation
The dividends in the next four years are:
Year 1: 6 × 0.4 = 2.4
Year 2: 9 × 0.4 = 3.6
Year 3: 13.5 × 0.4 = 5.4
Year 4: (13.5 × 1.02) × 0.8 = 11.016
The terminal value of the firm (in year 3) is 11.016 / (0.12 − 0.02) = 110.16. Value per share
= 2.4 / (1.2)1 + 3.6 / (1.2)2+ 5.4 / (1.2)3 + 110.16 / (1.2)3 = $71.38.