As an analyst at Chumem & Burnem Securities, you are responsible for making reco
ID: 2782526 • Letter: A
Question
As an analyst at Chumem & Burnem Securities, you are responsible for making recommendations to your firm's clients regarding common stocks. After gathering data on Denver Semiconductors, you have found that its dividend has been growing at a rate of 5% per year to the current (DO) $0.60 per share. The stock is now selling for $20 per share, and you believe that an appropriate rate ofretum for this stock is 9% per year. If you expect that the dividend will grow at a 5% rate into the foresecable future, what is the highest price at which you would recommend purchasing this stock to your clients? Suppose now that you believe that the company's new product line will cause much higher growth in the near future. Your new estimate is for a three-year period of 15% annual growth to be followed by a return to the historical 5% growth rate. Under these new assumptions b. what is the value using the two-stage dividend growth model? You now realize that it is likely that the growth will transition from 15% down to 5% gradually, rather than instantaneously. Ifyou believe c. that the transition will take five years, what is the value of the stock? Use theH-Model valuation methods.Explanation / Answer
D0 = $0.6/share
D1 = D0 * (1 +growth rate) = $0.6 * 1.05 = $0.63/share
P0 = $20
According dividend growth model,
Value of stock = D1/ (Rate of return - Growth rate) = $0.63/(9%-5%) = $15.75
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D1 = $0.6 * (1+15%) = $0.6 * 1.15 = $0.69
D2= $0.69 * (1+15%) = $0.69 * 1.15 = $0.7935
D3= $0.7935 * (1+15%) = $0.7935 * 1.15 = $0.9125
Value of the stock = D1/(1+rate ) + D2/(1+rate )2 + D3/(1+rate )3 + D3*(1+G1)/(Rate - G1/(1+rate ) 3
= 0.69/1.09 + 0.7935/1.092 + 0.9125/ 1.093 + 0.9125 * (1.05/0.04 )/ 1.093
= $23.299
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Value of stock as per H dividend model = D0 * ( 1 + GL)/ (Rate - GL) +D0 * H * (GS - GL)/(Rate - GL)
= 0.6 * (1+5%) /(9%-5%) + 0.6 * 2.5 * (15% - 5%)/ (9%-5%)
= 0.6 * 1.05/0.04 + 0.6 *2.5 * 0.1 /0.04 = $19.5
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