Scotto Manufacturing is a mature firm in the machine tool component industry. The firm’s most recent common stock dividend was $3.40 per share. Because of its maturity as well as its stable sales and earnings, the firm’s management feels that dividends will remain at the current level for the foreseeable future. a. If the required return is 12%, what will be the value of Scotto’s common stock? b. If the firm’s risk as perceived by market participants suddenly increases, causing the required return to rise to 5%, what will be the common stock value? c. Judging on the basis of your findings in parts a and b, what impact does risk have on value? Explain.
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.
Scotto Manufacturing is a mature firm in the machine tool component industry. The firm’s most recent common stock dividend was $3.40 per share. Because of its maturity as well as its stable sales and earnings, the firm’s management feels that dividends will remain at the current level for the foreseeable future. a. If the required return is 12%, what will be the value of Scotto’s common stock? b. If the firm’s risk as perceived by market participants suddenly increases, causing the required return to rise to 5%, what will be the common stock value? c. Judging on the basis of your findings in parts a and b, what impact does risk have on value? Explain.
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