3-1 Homework: Stock Valuation
Ariel Dorsey
Southern New Hampshire University
FIN 550: Corporate Financial Management
Professor Stotler, James
March 13, 2024
Turbo Technology Computers is experiencing a period of rapid growth. Earnings and
dividends are expected to grow at a rate of 15% during the next two years, at 13% in the third
year, and at a constant rate of 6% thereafter. Turbo's last dividend was $1.15, and the required
rate of return on the stock is 12%.
To calculate the value of the stock today using the dividend discount model (DDM), the
equation is as follows:
D0 * (1 + g1) * (1 + g2)
P0 = ______________________
(r – g2)
where (D0) = last dividend = $1.15, (g1) = growth rate for the next two years = 15%, (g2) =
growth rate in the third year = 13%, and (r) = required rate of return = 12%, the value of the
stock today is approximately $26.41 million. To calculate (P1) and (P2), we use the same formula
for (P0) but with different growth rates, giving results of (P1) = 7.83 and (P2) = 8.16. To calculate
the dividend yield and capital gains yield for Years 1, 2, and 3, the dividends for those years
using the given growth rates are discovered.
Year 1: D1 = D0 * (1 + g1) = 1.15 * (1 + 0.15) ≈ 1.32
Year 2: D2 = D1 * (1 + g1) = 1.32 * (1 + 0.15) ≈ 1.52
Year 3: D3 = D2 * (1 + g2) = 1.52 * (1 + 0.13) ≈ 1.72
From these calculations, the dividend yield and capital gains yield is calculated.
Year 1:
Dividend Yield = D1 / P0 ≈ 1.32 / 26.41 ≈ 0.0499 or about 4.99%
Capital Gains Yield = g1 ≈ 0.15 or 15%
Year 2:
Dividend Yield = D2 / P1 ≈ 1.52 / 7.83 ≈ 0.194 or about 19.4%
Capital Gains Yield = g1 ≈ 0.15 or 15%
Year 3:
Dividend Yield = D3 / P2 ≈ 1.72 / 8.16 ≈ 0.21or about 21%
Capital Gains Yield = g2 ≈ 0.13 or 13%
Kassidy's Kabob House has preferred stock outstanding that pays a dividend of $5 at the
end of each year. The preferred sells for $50 a share. Assuming the market is in equilibrium with
the required return equal to the expected return, the stock’s required rate of return will be
calculated. The required rate of return for the preferred stock is the dividend payment divided by
the price of the preferred stock giving a rate of return of 10%.
McCaffrey's Inc. has never paid a dividend, and when the firm might begin paying
dividends is not known. Its current free cash flow (FCF) is $100,000, and this FCF is expected to
grow at a constant 7% rate. The weighted average cost of capital (WACC) is 11%. McCaffrey's
currently holds $325,000 of non-operating marketable securities. Its long-term debt is
$1,000,000, but it has never issued preferred stock. McCaffrey's has 50,000 shares of stock
outstanding. McCaffrey's value of operations can be calculated using the discounted cash flow
(DCF) method:
FCF0 * (1 + g)
VO = _______________
WACC - g
where (FCF0)= current free cash flow = $100,000, (g) = growth rate = 7%, (WACC) = weighted
average cost of capital = 11%. McCaffrey's value of operations is $2,675,000.
The company's total value is the sum of the value of operations and non-operating
marketable securities, minus long-term debt, providing a result of 2,000,000. The company's
total value is $2,000,000. The estimated value of common equity is the total value minus the
long-term debt, equaling 1,000,000. The estimated value of common equity is $1,000,000. The
estimated per-share stock price is the value of common equity divided by the number of shares
outstanding resulting in an estimated per-share stock price of $20.
References
Institute, C. (2023). 2024 CFA Program Curriculum Level I Box Set. Wiley Professional
Development (P&T). https://mbsdirect.vitalsource.com/books/9781394220823
Sharpe, N. R., De Veaux, R. D., & Paul, F. V. (2019). Business statistics. Upper Saddle River,
NJ: Pearson.
