What is the value of the stock based on the dividend valuation model (Formula 10-9 on page 300)?
What is the value of the stock based on the dividend valuation model (Formula 10-9 on page 300)?
Allie Reynolds, the chief financial officer of Healthy Products, Inc., has been asked to do an evaluation of Fiber Cereals, Inc., by the president and chairman of the board, Gail Martinez. Healthy Products was planning a joint venture with Fiber Cereals (which was privately traded), and Gail and Allie needed a better feel for Fiber Cereals%u2019 common stock value because they thought they might be interested in buying the firm in the future.
Fiber Cereals paid a dividend at the end of year 1 of $1.35; the anticipated growth rate was 11 percent; and the required rate of return was 14 percent.
a. What is the value of the stock based on the dividend valuation model (Formula 10-9 on page 300)?
b. Indicate that the value you computed in part a is correct by showing the value of D1, D2, and D3 and discounting each to the present at 14 percent. D1 is $1.35 and it increases by 11 percent (g) each year. Also discounted back the anticipated stock price at the end of year 3 to the present and add it to present value of the three dividend payments.
The value of the stock at the end of year 3 is:
\(P3=D4/Ke-g D4=D3(1+g) \)
If you have done all these steps correctly, you should get an answer approximately equal to the answer in part a.
c. As an alternative measure, you also examine the value of the firm based on the price-earnings (P/E) ratio times earnings per share.
Since the company is privately traded (not in the public stock market), you will get your anticipated P/E ratio by taking the average value of five public traded food industry companies. These P/E ratios were as follows during the time period under analysis:
P/E Ratio
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