Bybee is expected to have a temporary supernormal growth period and then level off to a “normal,” sustainable growth rate forever. The supernormal growth is expected to be 25 percent for 2 years, 20 percent for one year and then level off to a normal growth rate of 8 percent forever. The market requires a 14 percent return on the company and the company last paid a $2.00 dividend. What would the market be willing to pay for the stock today? A) $47.09. B) $76.88. C) $52.68. D) $67.50. Your answer: A was incorrect. The correct answer was C) $52.68. First, find the future dividends at the supernormal growth rate(s). Next, use the infinite period dividend discount model to find the expected price after the supernormal growth period ends. Third, find the present value of the cash flow stream. D1 = 2.00 (1.25) = 2.50 (1.25) = D2 = 3.125 (1.20) = D3 = 3.75 P2 = 3.75/(0.14 - 0.08) = 62.50 N = 1; I/Y = 14; FV = 2.50; compute PV = 2.19. N = 2; I/Y = 14; FV = 3.125; compute PV = 2.40. N = 2; I/Y = 14; FV = 62.50; compute PV = 48.09. Now sum the PV’s: 2.19 + 2.40 + 48.09 = $52.68. Wouldnt you have to find D4 and use that as the final pay period since the final pay period is supposed to be Dn+1. The way I see this question D3 is still supernormal growth and D4 would be the first dividend using normal growth rate. What am I missing?
DIV1=DIVo(1+g_high)=2(1,25)=2.5 DIV2=DIV1(1+g_high)=2.5(1,25)=3.125 DIV3=DIV2(1+g_high)=3.125(1,20)=3.75 P3= DIV3(1+G) / r-g= 3.75(1,08)/0.14-0.08= 4.05/0.06= 67.5 Discount each cash flow: Pcs=2.5/(1,14) + 3.125/(1,14)^2 + (3.75 +67.5)/(1.14)^3=52.68
" DIV1=DIVo(1+g_high)=2(1,25)=2.5 DIV2=DIV1(1+g_high)=2.5(1,25)=3.125 DIV3=DIV2(1+g_high)=3.125(1,20)=3.75 P3= DIV3(1+G) / r-g= 3.75(1,08)/0.14-0.08= 4.05/0.06= 67.5 Discount each cash flow: Pcs=2.5/(1,14) + 3.125/(1,14)^2 + (3.75 +67.5)/(1.14)^3=52.6" perfect. Its a plain vanilla DCF except we’re discounting dividends instead of excess or “free” cash flow. (to be technical, FCF is converted to value by a CEO when they use it to repo shares, boost the dividend, etc. A firm that sits on massive FCF and does diddley with it = takeover target) Notice that a large chunk of the firm’s value rests on the TERMINAL DIVIDEND it pays shareholders, since the crux of DCF is that the firm will continue as a GOING CONCERN forever. This is one you can easily mess up on a calculator, since so many of us are trained to do it on Excel : )