The Boulder Brass Works Company (BBWC) is a small-capitalization machine shop th

Question

The Boulder Brass Works Company (BBWC) is a small-capitalization machine shop that has found a rapidly growing niche market for its custom-machined brass parts. Its business is growing so fast that it has decided not to pay dividends for the next 3 years. In year 4 it expects its growth to begin decelerating, and so plans to begin paying dividends. At the end of year 4 it plans to pay a dividend of $2.00. At the end of year 5 it plans to pay a dividend of $3.00. Beginning in year 6, BBWC's management believes that the company will have entered middle age. Management anticipates being able to sustain a dividend growth rate of 4% per year in year 6 and every year thereafter. Firms with similar growth and risk characteristics return 9% per year to their equity investors. What is BBWC's intrinsic value? You must show your work to receive full credit for this problem.

Explanation / Answer

This is a sum of 2 stage dvidend growth model - Stage 1 = Explicit forecast period - Year Dividend PV factor @9% PV of dividends 4 2 0.7084 1.42 5 3 0.6499 1.95 3.37 Stage 2 = Horizon period - V5 = D6/(Re-g) V5 = Value at the end of 5 years D6 = Dividend for year 6 = 3 x (1 + 4%) = 3.12 Re= Rate of return = 9% g = Growth rate = 4% V5= 3.12/(0.09-0.04) = 62.40 PV of V5 today = 62.4 x 0.6499 = 40.56 Intrinsic value = Stage 1 + stage 2 3.37 + 40.56 = 43.92

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