# Stock valuation

Hi, I need help understanding practice probelms 14 and 15 (page 153 & 154) from the CFA curriculum vol 5(security valuation). Please help! Thanks.

can you possibly post them here?

Sure… 14. net profit margin 4% total asset turnover 2.0 financial leverage (total assets/equity) 2.5 beta for the company’s stock 1.5 expected rate of return on the market index 12.0% risk free rate of return 5.0% The analyst expects the information above to acurately reflect the future. If the company wants to achieve a growth rate of 20% without changing its capital structure or issuing new equity, the minimum dividend payout ratio for the company would be closest to…? ------------------------------------------------------------------------------------------------------------------- 15. Current dividend per share on common stock \$ 3.00 Expected annual growth rate for years 1 and 2 = 20% Expected annual growth rate for year 3 and thereafter = 9% Expected risk free rate of return = 6 % Expected return on teh market portfolio = 11 % Beta for the common stock = 1.2 The value of a share of the company’s common stock is closest to…?

1. ROE = NPM * TAT * FL = 0.04 * 2 * 2.5 = 0.2 g = b.ROE b = Retention Ratio 20% = 0.2 = b * 0.2 so b = 1
1. This question requires knowledge of Gordon’s growth model and Du Pont Analysis g = bxROE where g=growth b=retention ratio ROE= return on equity the net profit(net income) can either be distributed to the shareholders as dividends or re-invested in the form of retained earnings. the retention ratio measures what proportion of the earnings is retained. the dividend payout ratio measures what proportion of earnings is distributed in the form of dividends. thus dividend payout = 1- retention ratio If that is clear, then u have growth rate but need to calculate ROE and b to find the payout ratio. Du Pont analysis ROE= net profit magin x asset turnover x leverage You’l get an ROE of 20% or 0.2 substitute into g = b x ROE b= 20% / 20%= 100% i.e. all earnings are retained. if all earnings are retained, then dividend payout should be 1- 100%= 1-1= 0%
1. multi-stage dividend discount model scenario you have a period of high growth rate followed by an infinite period of stable growth. the DDM with growth is MV 0f share = D1/(r-g) or D0(1+g)/(r-g) depending on whether you’r given the current dividend or future dividend in the question. D0= current dividend D1= dividend in 1 yrs time r= cost of equity/ required rate of return g= growth rate(same as in 14 above) Step1. Calculate cost of equity using CAPM r= 6 + (11-6)*1.2 = 12% Step2. Calculate what dividend will be in the 3rd year Current D0 = 3 Year 1 D1 = 3 * 1.2 = 3.6 (20% growth) Year 2 D2 = 3.6 * 1.2 = 4.32 (20% growth) Year3 D3 = 4.32 * 1.09 = 4.71 (9% growth) Step3. Calculate using DDM the pv of dividends with growth from 3rd year to infinity P2 = D3 / (r-g) = 4.71 / (.12 - 0.09) = 196.96 Step4. Now calculate the value of the stock by calculating PV of cashflows using ur calc Cashflow in Y1=D1=3.6 Cashflow in Y2= D2 + the value of dividend stream u calculated in Step3= 4.32+ 196.96 Discount rate= cost of equity= 12% hope it helps.

i think you guys are getting wrong figure here;P2 = D3 / (r-g) = 4.71 / (.12 - 0.09) = 196.96. it should be 156.96. here’s the solution below D0 = 3 D1 = 3 * 1.2 = 3.6 D2 = 3.6 * 1.2 = 4.32 D3 = 4.32 * 1.09 = 4.7088 r = 6 + 1.2 ( 11-6) = 6 + 6 = 12% P2 = D3 / (r-g) = 4.7088 / (.12 - 0.09) = 156.96 Use CF function CF1 = 3.6, CF2 = 4.32 + 156.96 r=12% and that will be 3.214 + 3.4439 + 125.12755 and hence stock value is \$131.79 Hope this helps

i didn’t calculate any figures myself. copied from the solution cpk123 provided. So please check yourselves. Thanks for the correction Finpaul.

Thanks all, for the help…it worked:)