59533341-FM11-Ch-07-Instructors-Manual-1

# The easiest way to value such nonconstant growth

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Unformatted text preview: st way to value such nonconstant growth stocks is to set the situation up on a time line as shown below: 0 r = 13% |s g = 30% 1 2 3 4 | | | | 2.600 g = 30% 3.380 2.301 2.647 3.045 46.116 54.109 g = 30% 4.394 Ö3 = \$66.54 = g = 6% 4.658 4.658 0.13  0.06 Simply enter \$2 and multiply by (1.30) to get D1 = \$2.60; multiply that result by 1.3 to get D2 = \$3.38, and so forth. Then recognize that after year 3, Temp Force becomes a constant growth stock, and at that point Ö3 can be found using the constant growth model. Ö3 is the present value as of t = 3 of the dividends in year 4 and beyond. With the cash flows for D1, D2, D3, and Ö3 shown on the time line, we discount each value back to year 0, and the sum of these four Vs is the value of the stock today, 0 = \$54.109. The dividend yield in year 1 is 4.80 percent, and the capital gains yield is 8.2 percent: § § § Dividend yield = \$2.600 = 0.0480 = 4.8%. \$54.109 Capital gains yield = 13.00% - 4.8% = 8.2%. During the nonconstant growth period, the dividend yields and capital gains yields are not constant, and the capital gains yield does not equal g. However, after year 3, the stock becomes a constant growth stock, with g = capital gains yield = 6.0% and dividend yield = 13.0% - 6.0% = 7.0%. Mini Case: 7 - 21 h. Answer: Is the stock price based more on long-term or short-term expectations? Answer this by finding the percentage of Temp Force current stock price based on dividends expected more than three years in the future. \$46.116 = 85.2%. \$54.109 Stock price is based more on long-term expectations, as is evident by the fact that over 85 percent of temp force stock price is determined by dividends expected more than three years from now. i. Suppose Temp Force is expected to experience zero growth during the first 3 years and then to resume its steady-state growth of 6 percent in the fourth year. What is the stock¶s value now? What is its expected dividend yield and its capital gains yield in year 1? In year 4? Answer: Now...
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