Problem 3: (15 points) General Mills (NYSE: GIS) is a large manufacturer and dis

Question

Problem 3: (15 points)

General Mills (NYSE: GIS) is a large manufacturer and distributor of package consumer food products. Benoit Gagnon, a buy-side analyst covering General Mills, has studied the historical growth rates in sales, earnings, and dividends for GIS, and also has made projections of future growth rates. Gagnon expects the current dividend of 1.10 per share to grow at 6 percent for the next five years, and that the growth rate will decline to 3 percent and remain at that level thereafter.

The risk-free rate is 4%, the market risk premium is 6%, and GIS’s beta, assumed to be 0.50.

Required:

Calculate the required rate of return on equity for General Mills as of the beginning of Year +1.

Calculate the sum of the present value of total dividends for Years +1 through +5.

Calculate the continuing value of General Mills at the start of Year +6 using the constant growth model with Year +6 total dividends.

Calculate the present value of continuing value as of the beginning of Year +1.

Compute the value per share of General Mills as of the beginning of Year +1. Remember to adjust the present value for midyear discounting.

Explanation / Answer

1. Required rate of return on equity at the beginning of year +1 = RF +RP m (b)
= 0.04 + (0.06*0.5)
= 7.00%

2. Calculation of sum of the Present Value of total dividends for year +1 through year +5:

3. As per constant growth Dividend Discount Model:
Continuing Value of General Mills = [ D5 * (1+ g) ] / (Re - g)
= (1.39 * 1.06) / (0.07 - 0.06)
= 147.20

4. PV of continuing value as of the beginning of year +1 = Continuing Value * PVIF (7%,5th year)
= 147.20 * 0.7130
= 104.95

5. Value Per share as of the beginning of Year +1:
Sum of PV of dividend = 5.05
Present Value of continuing value = 104.95
Total   = 110.00
Mid Year discounting adjustment(1+(0.07/2) = 1.035
Total PV of Equity (110*1.035) = 113.85

Value per share = Total PV of Equity / No. of Shares
(Assuming no. of shares to be 100 as not given in question)
Therefore, value per share = 113.85 / 100 = 1.1385

Particulars Year +1 Year +2 Year +3 Year +4 Year +5 Total Dividend 1.10 1.17 1.24 1.31 1.39 P.V factor @ 7% 0.9346 0.8734 0.8163 0.7629 0.7130 Total P.V 1.03 1.02 1.01 1.00 0.99 5.05

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