Q-1. (A)Your broker offers to sell you some shares of Bahnsen & Co. common stock that paid a dividend of $3.5 yesterday. Bahnsen’s dividend is expected to grow at 10%, 12% and 18% per year for the next 3 years respectively. If you buy the stock, you plan to hold it for 3 years and then sell it. Bahnsen’s beta is β = 1.8, risk free rate is RF = 6.5% and risk-premium on market is RPM = 7%. i. Find the expected dividend for each of the next 3 years. ii. Given that the first dividend payment will occur 1 year from now, find the present value of the dividend stream and then sum these PVs. iii. You expect the price of the stock 3 years from now to be $65.00. Discounted at a required rate of return, what is the present value of this expected future stock price?
Dividend Valuation
Dividend refers to a reward or cash that a company gives to its shareholders out of the profits. Dividends can be issued in various forms such as cash payment, stocks, or in any other form as per the company norms. It is usually a part of the profit that the company shares with its shareholders.
Dividend Discount Model
Dividend payments are generally paid to investors or shareholders of a company when the company earns profit for the year, thus representing growth. The dividend discount model is an important method used to forecast the price of a company’s stock. It is based on the computation methodology that the present value of all its future dividends is equivalent to the value of the company.
Capital Gains Yield
It may be referred to as the earnings generated on an investment over a particular period of time. It is generally expressed as a percentage and includes some dividends or interest earned by holding a particular security. Cases, where it is higher normally, indicate the higher income and lower risk. It is mostly computed on an annual basis and is different from the total return on investment. In case it becomes too high, indicates that either the stock prices are going down or the company is paying higher dividends.
Stock Valuation
In simple words, stock valuation is a tool to calculate the current price, or value, of a company. It is used to not only calculate the value of the company but help an investor decide if they want to buy, sell or hold a company's stocks.
Q-1. (A)Your broker offers to sell you some shares of Bahnsen & Co. common stock that
paid a dividend of $3.5 yesterday. Bahnsen’s dividend is expected to grow at 10%, 12%
and 18% per year for the next 3 years respectively. If you buy the stock, you plan to
hold it for 3 years and then sell it. Bahnsen’s beta is β = 1.8, risk free rate is RF = 6.5%
and risk-premium on market is RPM = 7%.
i. Find the expected dividend for each of the next 3 years.
ii. Given that the first dividend payment will occur 1 year from now, find the present
value of the dividend stream and then sum these PVs.
iii. You expect the price of the stock 3 years from now to be $65.00. Discounted at a
required
iv. If you plan to buy the stock, hold it for 3 years, and then sell it for $65.00, what is the
most you should pay for it today?
v. Using constant dividend growth model, calculate the price of this stock today. Assume
that g is 8% and that it is constant.
vi. Is the value of this stock dependent upon how long you plan to hold it? In other words,
if your planned holding period was 2 years or 5 years rather than 3 years, would this
affect the value of the stock today? Explain.
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