 # DDM

Given the following estimated financial results, value the stock of FishnChips, Inc., using the infinite period dividend discount model (DDM). * Sales of \$1,000,000 * Earnings of \$150,000 * Total assets of \$800,000 * Equity of \$400,000 * Dividend payout ratio of 60.0% * Average shares outstanding of 75,000 * Real risk free interest rate of 4.0% * Expected inflation rate of 3.0% * Expected market return of 13.0% * Stock Beta at 2.1 The per share value of FishnChips stock is approximately: (Note: Carry calculations out to at least 3 decimal places.) A) \$17.91. B) Unable to calculate stock value because ke < g. C) -\$26.39. D) \$26.86.

g = ROE*RR = (150/400)*40% = 15% rfr = (1.04)*(1.03) -1 = 7.12% ke = rfr+beta*(r(m)-rfr) = 7.12%+2.1*(13%-7.12%) = 19.5% D1 = EPS*PR = (150000/75000)*.6=2*.6=\$1.2 P = D1/(ke-g)=\$1.2/(19.5%-15%)=\$26.67 answer D

I get an answer of \$50 which is none of the above :S Anyone else have any suggestions?

d

Ok got it Good one maratikus. I missed the D1 = EPS*PR step and went ahead with teh calc and got a wrong answer. I got D as well now.

yep well done all the answer is d. if anyone wants me to post calculations from schweser let me know!

rf = (1+rrf) ( 1+E(inf)) - 1 = 1.04 * 1.03 - 1 = 7.12% also can be approximated by rrf + inf = 7% rce = rf + beta ( rm - rf ) = 7.12 + 2.1 ( 13 - 7.12) = 19.468% g = ROE * (1-k) = ROE = 150 / 400 * (.4) = 15% E = 150/75 = 2 (earnings per share) P = 2 * .6 / (.19468-.15) = 26.87 Answer D

I have a question. How did you guys assume to add inflation to the risk free rate? I understand why you did it, but if I were to read this question, I would assume 4% is the risk free rate and you would use that in the formula, i.e., 9% would be the market premium (13-4).

It says REAL RISK FREE RATE. and I believe either in Corp Fin (CAPM) chapter, or in Portfolio management, as well as the very first chapter in Quant – they talk about getting to the actual Risk Free rate (nominal) using the real rate and the Expected rate of inflation. That is something additional they are testing on this question. CP

Should we not have D1=1.2 x (1+g)?

Sondin, i was thinking about estimating D1 as 1.2*(1+g) but then it says the the provided numbers are estimate and it’s D1 (not D0) that’s equal to 1.2.

Thanks maratikus, I was doing the same thing except my D1 is different as above which gave me the answer of around \$30. (which is none of the options).

I agree with sondin: D1 =E1/shares * (1+g) . so unless somebody can confirm that "Earnings of \$150,000 " means ‘expected’ earnings,I get a value of around 31

Given the following estimated financial results, value the stock of FishnChips, Inc., using the infinite period dividend discount model (DDM). I think the key word is ESTIMATED above…