Question #111 - Reading 20 Discounted Dividend Valuation

Reading: Reading 20 Discounted Dividend Valuation

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Shared Context

- Davidson needs to determine if the shares of Wellborn are currently undervalued or overvalued in the market relative to the shares' fundamental value. The estimated fair value of Wellborn shares, using a two-period dividend discount model (DDM), is: A) $27.69. B) $27.58. C) $25.29.

Question

Davidson determines that over the past three years, Samson has maintained an average net profit margin of 8 percent, a total asset turnover of 1.6, and a leverage ratio (equity multiplier) of 1.39. Assuming Samson continues to distribute 35 percent of its earnings as dividends, Samson's estimated sustainable growth rate (SGR) is:

Answer Choices:

A. 6.2%

B. 17.8%

C. 11.6%

Explanation

Utilizing the PRAT model, where SGR is a function of profit margin (P), the retention rate (R), asset turnover (A) and financial leverage (T): g = P × R × A × T g = 0.08 × (1 − 0.35) × 1.6 × 1.39 = 0.116 = 11.6%.

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