Dividend Discount Mod

Constant Dividend/ Zero Growth

D 0 (1  g
Dividend Growth Model

P0 
R -g

g = (retention ratio
g = ( 1- payout ratio
—Dividend yield
D1/P0 = Dividend/Current Price
—Capital gains yield
(P1 – P0)/P0
Change in the Price/ beginning Price
—Total return (rs)
Dividend yield + Capital gains yield

Q. 1

Fee Founders has perpetual stock outstanding that sells for $60 a share and pays a dividend of $5 at the end of

P
D
r?

Q. 2

Allied Food Products just paid a dividend of $1.15, and the dividend is expected to grow at a constant rate of 8.3%.
a 13.7% required return?
 Allied Food Products just paid a dividend of $1.15, and the dividend is expected to grow at a constant rate of 8.3%.
a 13.7% required return?

D0
g
r
P = D0*(1+g)/(r-g)

Q.3
You buy a stock for $23.06, and you expect the next annual dividend to be $1.245. Furthermore, you ex
expected rate of return and dividend yield on the stock? If the curret trading price

P
D1
g
r?
Div yield 5.40%

capital gain yield 25.76%

TOTAL RETURN = DIV YIELD+CAPITAL GAIN YIELD

Q.4

A company just paid a $1.15 dividend, and it is expected to grow at 30% for the next 3 years. After 3 ye
indefinitely. If the required return is 13.4%, what is the stock's

D0 $1.15
rs 13.4%
gs 30% Short-run g; for Years 1-3 only.
gL 8% Long-run g; for Year 4 and all following years.

YEARS DIVIDENDS EXPECTED CASHFLOWS

1 D1 1.50
2 D2 1.94
3 D3 2.53
3 P3 50.531
PRICE OF THE STOCK TODAY = SUM OF PVs
Q.5

A perpetual preferred stock pays a $10 annual dividend and has a required return of 10.3%

D 10
R 10.30%
P 97.087

Q6. If D1 = $2.00, g = 6%, and P0 = $40, what is the stock’s expected dividend yield, capital gains yield, and total expe
year? If P1 = $45.
D1 $2.00
g 6%
P0 $40.00

Exp. dividend yield 5.0%

Exp. capital gains yield 12.5%
Exp. total return 17.5%

Q. 7
A stock is expected to pay a dividend of $1 at the end of the year. The required rate of return is rs = 11%.
what would the stock’s price be if the growth rate was 5%?

D1 $1.00
g 5%
rs 11%

Stock price $16.67

Q. 8

A stock is expected to pay a dividend of $1 at the end of the year. The required rate of return is rs = 11%.
what would the stock’s price be if the growth rate was 0%?

Price
Q. 9 Firm B has a 12% ROE. Other things held constant, what would its expected growth rate be if it paid out 25% of
dividends?

ROE 12%
Payout ratio 25.00%
g 9%

Q. 9 b

What would its expected growth rate be if it paid out 75% of its earnings as dividends?

g = (1 – payout)ROE = 3.00%

Suppose a firm is expected to increase dividends by 20% in one year and by 15% in two
years. After that dividends will increase at a rate of 5% per year indefinitely. If the last
dividend was Rs.1 and the required return is 20%, what is the price of the stock?

D0 $1.00
rs 20.0%
gs 20%
gs 15%
gL 5%

YEARS DIVIDENDS
1 D1
2 D2
3 D3
3 P3
PRICE OF THE STOCK TODAY = SUM OF PVs
 Dividend Discount Model

P = D/R

D 0 (1  g) D1
 
R -g R -g

retention ratio * ROE)

1- payout ratio * ROE)

60 a share and pays a dividend of $5 at the end of each year. What is the required rate of return?

₹ 60.00
5 P= D/r
8.33% r = D/P

nd is expected to grow at a constant rate of 8.3%. What stock price is consistent with these numbers, assuming
a 13.7% required return?
 1.15
8.30%
13.70%
23.06

ual dividend to be $1.245. Furthermore, you expect the dividend to grow at a constant rate of 8.3%. What is the
nd yield on the stock? If the curret trading price is $29 what will be the capital gain yield?

23.06
1.245 r = (D1/P)+g
8.30%
13.7% P =D1/(r-g)

d to grow at 30% for the next 3 years. After 3 years the dividend is expected to grow at the rate of 8%
he required return is 13.4%, what is the stock's value today?

rs 1-3 only.
r 4 and all following years.

PV OF CASHFLOWS
1.318 D1/(1+r)^1
1.511 D2/(1+r)^2
1.733 D3/(1+r)^3
34.651 P3/(1+r)^3
39.213
nual dividend and has a required return of 10.3%. What is its value?

ividend yield, capital gains yield, and total expected return for the coming
If P1 = $45.

Dividend/Price
(P1-P0)/P0
Dividend Yield + Capital gains Yield

year. The required rate of return is rs = 11%. Other things held constant,
s price be if the growth rate was 5%?

Price = D1/(r-g)

year. The required rate of return is rs = 11%. Other things held constant,
s price be if the growth rate was 0%?

D1 $1.00
g 0%
rs 11%
$9.09 Price = D1/(r-g)
d its expected growth rate be if it paid out 25% of its earnings as
dends?

g = (1-payout ratio) * ROE

out 75% of its earnings as dividends?

% in one year and by 15% in two

% per year indefinitely. If the last
what is the price of the stock?

Short-run g; for Year 1 only.

Short-run g; for Years 2-3 only.
Long-run g; for Year 4 and all following years.

EXPECTED CASHFLOWS
PV OF CASHFLOWS
1.20 1.000 D1/(1+r)^1
1.38 0.958 D2/(1+r)^2
1.59 0.918 D3/(1+r)^3
11.109 6.429 P3/(1+r)^3
DAY = SUM OF PVs 9.306
 Bon Temps embarked on an aggressive expansion that requires additional capital. Management decided to
by borrowing $40 million and by halting dividend payments to increase retained earnings. Its WACC is now
free cash flows for the next 3 years are -$5 million, $10 million, and $20 million. After Year 3, free cash flow
constant 6%. What is Bon Temps’s total value? If it has 10 million shares of stock and $40 million of deb
combined, what is the price per share?

Expected
FutureFCF
INPUT DATA: (Dollars in Millions) Year FutureFCF (in millions)
(in millions)

WACC 10% 1 FCF1 -$5.0

MV OF DEBT 40.00 2 FCF2 $10.0

g 6% 3 FCF3 $20.0
V3=
FCF3*(1+g)/
no. of shares 10.00 3 (WACC-g) $530.0

value of firm = Sum of

Value of Firm = MV of equity + MV of Debt & Pref Stock - Any cash and cash equivalen

MV of Equity = Value of Firm - MV of Debt+ cash & cash equivalent

MV of Equity ###
Price per stock = MV of equity/ No. of outstanding shares ###

TTC recently introduced a new line of products that has been wildly successful. On the basis of this
success and anticipated future success, the following free cash flows were projected:

Year FCF (in millions)

1 $5.5
2 $12.1
3 $23.8
4 $44.1
5 $69.0
6 $88.8
7 $107.5
 8 $128.9
9 $147.1
10 $161.3

After the 10th year, TTC's financial planners anticipate that its free cash flow will grow at a constant rate
of 6%. Also, the firm concluded that the new product caused the WACC to fall to 9%. The market value
of TTC's debt is $1,200 million, it uses no preferred stock, and there are 20 million shares of common
stock outstanding. Use the corporate valuation model approach to value the stock.

INPUT DATA: (Dollars in Millions)

WACC 9%
MV OF DEBT 1200.00
g 6%
no. of shares 20.00
Year FCF (in millions)
1 $5.5
2 $12.1
3 $23.8
4 $44.1
5 $69.0
6 $88.8
7 $107.5
8 $128.9
9 $147.1
10 $161.3
PV of FCF
$ 5.05 FCF1/(1+WACC)^1
$ 10.18 FCF2/(1+WACC)^2
$ 18.38 FCF3/(1+WACC)^3
$ 31.24 FCF4/(1+WACC)^4
$ 44.85 FCF5/(1+WACC)^5
$ 52.95 FCF6/(1+WACC)^6
$ 58.81 FCF7/(1+WACC)^7
$ 64.69 FCF8/(1+WACC)^8
$ 67.73 FCF9/(1+WACC)^9
$ 68.13 FCF10/(1+WACC)^10

V10
V10 =FCF10*(1+g)/(WACC-g) 5699.27 $ 2,407.43 V10/(1+WACC)^10

Value of Firm = sum of all

PV of Future cashflows $ 2,829.44

MV OF EQUITY = VALUE OF FIRM - MV OF DEBT $ 1,629.44

Price per stock = MV OF EQUITY / NO. OF OUTSTANDING STOCKS $ 81.47

Burklin, Inc., has earnings of $21 million and is projected to grow at a constant rate of 5 percent forever because o
gained from the learning curve. Currently, all earnings are paid out as dividends. The company plans to launch a n
two years from now that would be completely internally funded and require 30 percent of the earnings that year.
would start generating revenues one year after the launch of the project and the earnings from the new project in
estimated to be constant at $6.7 million. The company has 7.5 million shares of stock outstanding. Estimate the v
Burklin, Inc., has earnings of $21 million and is projected to grow at a constant rate of 5 percent forever because o
gained from the learning curve. Currently, all earnings are paid out as dividends. The company plans to launch a n
two years from now that would be completely internally funded and require 30 percent of the earnings that year.
would start generating revenues one year after the launch of the project and the earnings from the new project in
estimated to be constant at $6.7 million. The company has 7.5 million shares of stock outstanding. Estimate the v
stock. The discount rate is 10 percent.
INPUT DATA: (Dollars in Millions)

Earnings 21 Year FCF (in millions)

Number of shares 7.5 1 D1 =D0*(1
g 5% 2 D2 = 0.7*
r 10% 3 D3 = D0*(

P3 from
earnings
=
D3*(1+5
D0 = 21/ 7.5 2.8 3 %)/(r-5%)

P3from
project =
Project
Project Income from 3rd Dividend/
year 6.7 3r

Price of
stock =
sum of all
Project Dividend =6.7/7.5 0.89 PVs

Time line 0 1 2

launch of
project
so
30%earni
ngs
invested,
D2 will
be grown
only by
21 m earnings and earnings 70% of
7.5 m shares gown by 5% D1
4
Fincher Manufacturing has projected sales of $135 million next year. Costs are expected to be $76 million and ne
these values is expected to grow at 14 percent the following year, with the growth rate declining by 2 percent per y
is expected to remain indefinitely. There are 5.5 million shares of stock outstanding and investors require a retur
corporate tax rate is 40 percent.
1. What is your estimate of the current stock price?

2. Suppose instead that you estimate the terminal value of the company using a PE multiple. The industry PE mu

0
growth rates
I. Investment Outlays
CAPEX
II. Project Operating Cash Flows
sales
Operating costs (w/o deprn)
Depreciation
EBIT (Operating income)
Taxes on operating income 40%
EBIT (1 ‒ T) = AT operating income
Depreciation
EBIT (1 ‒ T) + DEP
(Capex)
EBIT (1 ‒ T) + DEP-capex
Project Free Cash Flows
Terminal Value (V6 = FCF6*(1+g)/(WACC-g)
Discount rate 13%
Years
PV of FCF
Value of firm = sum of PVs

Input data for Price per stock (vlaue in million)

MV of Debt 0 No information so assuming ze
No. of
Outstanding
shares 5.5

Value of Firm = MV of Debt - MV of Equity

MV of equity = Value of Firm - MV of Debt
Price per share = MV of equity/ No. of outsta
 apital. Management decided to finance the expansion
ned earnings. Its WACC is now 10%, and the projected
n. After Year 3, free cash flow is projected to grow at a
of stock and $40 million of debt and preferred stock
r share?

PV of FCF
-4.55 FCF1/(1+WAAC)^1

8.26 FCF2/(1+WAAC)^2

15.03 FCF3/(1+WAAC)^3

398.20 V3/(1+WAAC)^3

416.94

- Any cash and cash equivalents

376.94

Value of Firm - Value of debt

he basis of this
row at a constant rate
%. The market value
hares of common

FCF1/(1+WACC)^1
FCF2/(1+WACC)^2
FCF3/(1+WACC)^3
FCF4/(1+WACC)^4
FCF5/(1+WACC)^5
FCF6/(1+WACC)^6
FCF7/(1+WACC)^7
FCF8/(1+WACC)^8
FCF9/(1+WACC)^9
FCF10/(1+WACC)^10

V10/(1+WACC)^10

e of 5 percent forever because of the benefits

The company plans to launch a new project
ercent of the earnings that year. The project
earnings from the new project in any year are
stock outstanding. Estimate the value of the
 FCF (in PV of
millions) FCF
2.94 2.673 D1/ (1+r)^1
2.16 1.786 D2/ (1+r)^2
3.24 2.435 D3/ (1+r)^3

P3 from
earnings/
68.07 51.141 (1+r)^3

P3from
project/
8.93 6.712 (1+r)^3

64.746

3 4 5

5%
growth
in
earnings 5% growth
of firm in earnings
5% growth in and 6.7 of firm and
earnings of m 6.7 m
firm and 6.7 earning earning
m earning from from
from project project project
 xpected to be $76 million and net investment is expected to be $15 million. Each of
h rate declining by 2 percent per year until the growth rate reaches 6 percent, where it
ing and investors require a return of 13 percent return on the company’s stock. The
rate is 40 percent.

PE multiple. The industry PE multiple is 11. What is your new estimate of the company’s stock price?

Years
1 2 3 4 5 6
14% 12% 10% 8% 6%

15.00 17.10 19.15 21.07 22.75 24.12

135 153.90 172.37 189.60 204.77 217.06

76 86.64 97.04 106.74 115.28 122.20
- - - - - -
$ 59 $ 67 $ 75 $ 83 $ 89 $ 95
24 27 30 33 36 38
$ 35 $ 40 $ 45 $ 50 $ 54 $ 57
- - - - - -
$ 35 $ 40 $ 45 $ 50 $ 54 $ 57
$ 15 $ 17 $ 19 $ 21 $ 23 $ 24
20 23 26 29 31 33
$ 20 $ 23 $ 26 $ 29 $ 31 $ 33
+g)/(WACC-g) $ 496.69

1 2 3 4 5 6
$ 18.1 $ 18.2 $ 18.1 $ 17.6 $ 16.8 $ 254.3
$ 343.0

(vlaue in million)
No information so assuming zero

m = MV of Debt - MV of Equity
y = Value of Firm - MV of Debt $ 343.01
are = MV of equity/ No. of outstanding shares $ 62.37
 Bon Temps embarked on an aggressive expansion that requires additional capital. Management de
expansion by borrowing $240 million as secured loans and $255 million as unsecured loans and pre
with halting dividend payments to increase retained earnings. Its expected sales from this expna
million. Management expects to earn $261 million EBITDA and $25 million PAT. If it has 10 millio
perform the stock valaution of Bon Temps following relative valaution using comparable firm m
Information on its peers are as follows:

Trading Comparables
Sl. No. Company EV Mkt Cap EV/ Sales (x)
FY13A FY14A FY15P
A Company A 1,169 989 1.4x 1.3x 1.1x
B Company B 1,321 1,254 1.1x 1.2x 1.1x
C Company C 1,456 1,342 1.5x 1.7x 1.5x
D Company D 1,289 1,432 1.0x 0.9x 0.8x
E Company E 987 1,100 2.0x 1.6x 1.5x
Mean 1,244 1,223 1 1 1.2
Median 1,289 1,254 1 1 1

Relative Valuation on the Basis of EV/Sales Multiple

Sales 860

MEAN (EV/SALES)* SALES OF BON TEMP

VALUE OF FIRM EV OF BON TEMP 1,039.82
VALUE OF FIRM = MV OF EQUITY+MV OF DEBT
MV OF EQUITY = EV OF BON TEMP - MV OF DEBT $ 544.82
PRICE PER STOCK = MV OF EQUITY/ NO. OF STOCKS $ 54.48

Relative Valuation on the Basis of EV/EBITDA Multiple

Enterprise value of firm 895.23 Avg (EV/EBITDA) *EBITDA of Bon Temps

EV = Market Value of Debt+ Market value of Equity 400.23

Market Value of Equity = EV- MV of Debt 40.02

Price per share = MV of equity/ No. of outstanding shares

Relative Valuation on the Basis of P/E Multiple
 Market value fo equit 227.0 Avg (P/E) *PAT of Bon Temps

EPS=PAT/No. of shares
Price per share = MV of equity/ No. of outstanding shares

22.70

Core Industries is considering acquiring Duo Systems through a hostile takeover. Their plan is to m
Systems. Eva Fox, a financial analyst with Core, has been asked to estimate a fair acquisition price
valuation methods to estimate the acquisition price and has gathered the requir

Duo Systems Statistics

Earnings per share (EPS) ($) 2
Book value per share ($) 10
Sales per share ($) 30

Duo Systems has 1 million shares outstanding. From sixth year onwards, Fox expects Duo’s free cash fl
determines that Duo’s weighted average cost of capital of 9.5% is the appropriate d

Fox did some research and found three companies from the same industry as Duo, and with a similar ca
Dynamics. In addition, Fox could gather data for three takeover transactions with characteristics similar to
Data gathered by Fox are shown in the following fig

Comparable Company Analysis

Mouse
Corporati
- on Pad Inc.
Comparable Company Statistics
 P/E Ratio
P/B Ratio
P/S Ratio

Estimate the intrinsic price that Core Industries should pay for the Duo System using co

Estimted Duo Systems Stock Value

Based on P/E Ratio
Based on P/B Ratio
Based on P/S Ratio
Mean Estimated Stock Value
onal capital. Management decided to finance the
n as unsecured loans and preference shares along
pected sales from this expnasion plan is $ 860
illion PAT. If it has 10 million shares outstanding,
ion using comparable firm mulitple appraoch .
follows:

EV/ EBITDA (x) P/ E (x)

FY13A FY14A FY15P FY13E FY14A FY15P
4.1x 3.7x 3.4x 15.1x 11.7x 9.3x
4.7x 4.3x 3.6x 17.8x 12.2x 8.7x
4.8x 4.4x 3.8x 16.1x 12.6x 9.7x
4.1x 3.9x 3.5x 15.6x 12.3x 9.0x
3.8x 3.5x 3.1x 13.6x 11.3x 8.7x
4 4 3.4 16 12 9.1
4 4 3 16 12 9

Input Data Bon Temps

No. of shares

le takeover. Their plan is to make a tender offer directly to the shareholders of Duo
imate a fair acquisition price for the offer. Fox has considered using three different
e and has gathered the required financial data for this purpose.

, Fox expects Duo’s free cash flows to grow at a constant rate of 7% per year. She also
tal of 9.5% is the appropriate discount rate to use for the analysis.

ry as Duo, and with a similar capital structure—Mouse Corporation, Pad Inc., and Wire
s with characteristics similar to Duo—Page Corporation, Cover Industries, and Wrap Corp.
x are shown in the following figure.

Wire Mean
Dynamics Ratio
ay for the Duo System using comparable company analysis.
P 10800
FV 10000
CR 10%
CP 1000
n 10

YTM/rate 9%

n 10
cr 0
fv 20000
cp 0

($9,263.87)