Assignment 5

 

Common stock valuation using Dividend Discount Model and P/E technique

 

Assignment No. 4

Marks: 3

Due Date: MBA A+B = June 9, 2010

                     

 

 

The assignment must be done in groups formed previously. 

 

Stock valuation using Dividend Discount Model

 

Take dividends of the assigned compaies in the last 5 years.

 
  1. Find out the dividend per share for both companies in each of the five years
  2. Take the required rate of return either from Fama and French model or CAPM (if RRR from CAPM/ FAMA model is negative, then calculate RRR from P/E ratio)
  3. Analyze the dividend behavior of the companies and tell whether the dividend payouts show zero growth, constant growth or multi-stage growth
  4. According to the growth model you found out, find out the intrinsic value of the firm
  5. If the company dividend payout does not show any a straight forward growth rate, ( e.g Rs.8 dividend in 2000, Rs.10 in 2001, Rs.9 in 2002, Rs.8 in 2003 and Rs.10 in 2004 etc) then calculate present value of the  five years dividends individually and after fifth year assume that dividends growth rate becomes contants at a rate of::
    1. 1%
    2. 2%
    3. 3%
    4. 4%
    5. 5%
  6. That means that with the above 5 assumptions about the growth rates, you will have to calculate 5 different intrinsic values for each company using DDM
  7. As DDM is forward looking, the intrinsic value should be compared the market share price of the company in the first year,not in the last year. 
 


 

Using the multi-stage growth model

 
 
 
 
 P = Do(1+g)/ (k-g)    

 

Compare the intrinsic value with the actual share price to tell whether the stock is under valued or over valued

 

 

Stock valuation using P/E technique

 

Find out the intrinsic value of the companies by using the P/E technique.

 

Intrinsic value = P/E x EPS1

 

Eps1 is the next year expected EPS: You can find that out by finding the yearly growth rate in EPS of last five years and then using geometric mean find out the average growth rate. Multiply the average growth rate with the present year EPS to find out the next year EPS1



Example of Geometric mean =

 

Year

EPS

Growth

2000

8

 

2001

10

0.25

2002

9

-0.10

2003

8

-0.11

2004

10

0.25

  

GM = [(1+.25) x (1-0.1)) x (1-0.11) *-x (1+0.25)]1/n – 1

       = [1.25 x 0.8 x 0.89 x 1.25]1/4 -1

      = [1.25]1/4 – 1

       = 1.057 -1

      = .057 5.7%

 EPS1 for year 2005 will be: EPSo x (1+growth rate)


= 10x(1+.057) => 10.57


Or you can take the expected EPS of the next year from a brokerage house or any other analysts. In that case, make sure you provide the supportive tables or any other data that to provide evidence for the validity of EPS1

 

Compare the intrinsic value with the actual share price to tell whether the stock is under valued or over valued






 

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