The Denver Dairy Company has just come up with a new lactose free dessert produc
ID: 2713923 • Letter: T
Question
The Denver Dairy Company has just come up with a new lactose free dessert product for people who can't eat or drink ordinary dairy products. Management expects the new product to fuel sales growth at 30% for about two years. After that competitors will copy the idea and produce similar products, and growth will return to about 3% which is normal for the dairy industry in the area. Denver Dairy recently paid an annual dividend of $2.60, which will grow with the company. The return on stocks like the Denver Dairy Company is typically around 10%. What is the most you would pay for a share of Denver Dairy? Out-Tech Corp. has been struggling lately, and analysts foresee a long period of zero growth for the firm. It's been paying a yearly dividend of $4 for some time, which is expected to continue indefinitely. The yield on the stock of similar firms is 7.5%. What should Out-Tech's stock sell for?Explanation / Answer
Answer (5)
Price which can be paid for a Share of Denver Diary = $ 60.06
Current Dividend D0 = $ 2.60
Expected growth rate of sales = 30% for two years
Growth rate after 2 years = 3%
Return on stocks like Denver = 10%
Given that the dividends growth is in line with growth of the company
Dividend in year1 = $ 2.60 * 1.30 = $ 3.38
Dividend in year 2 = $ 3.38 * 1.30 = $ 4.394 or $ 4.39 (rounded off)
Dividend in year 3 = $ 4.39 * 1.03 = $ 4.5217 or $ 4.52 (rounded off)
Value of stock at the end of year 2 = Expected dividend in year 3 / (return on stock – growth rate)
= $ 4.52 / (0.10 – 0.03) = $ 4.52 / 0.07 = $ 64.5714 or $ 64.57
Intrinsic value of the stock = Dividend 1/(1+return) + Dividend 2 / (1+return)^2 + Value of stock/(1+return)^2
Intrinsic Value of the stock = $ 3.38/1.10 + $ 4.39/1.10^2 + $ 64.57/1.10^2
= 3.0727 + 3.6281 + 53.3636
= $ 60.0644 or $ 60.06 (rounded off)
Answer (6)
Price of Out-Tech stock = $ 53.33
Constant Dividend = $ 4
Growth rate = 0
Yield on stocks of similar firms = 7.5% or 0.075
Intrinsic Value of stock = $4/0.075 = $ 53.333 or $ 53.33 (rounded off)
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