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Stock Valuation: You are asked to valuate two stocks in different stage of their life cycle.
a) Stock one is in a relative declining industry: Suppose that the company of stock one will pay one terminal dividend at the end of year two, then go out of business, with a liquidation price of $10 per share. The dividend is as yet unknown but based on a thorough analysis of all public information, investors agree on the following distribution:
Possible Dividend |
Probability |
$10 |
0.4 |
$5 |
0.4 |
$2 |
0.2 |
Suppose investors rationally use the CAPM to discount
In addition, based on all public information, it is believed that Beta of the stock is 1.5, the expected market index return is 15%, and riskless rate is 5.0%. Using this information, calculate: what is the current share price of the company?
b) Stock Two-DGC Co. is in a consolidation industry: The DGC company just paid a dividend of $1 per share. The dividend is expected to grow at a rate of 20% per year for the next 2 years, and then to level off to 5% per year forever. Analysts predict that the expected rate of return for the company stock is 20% per year. What is the intrinsic value of a share of the stock?
c) Surprisingly, DGC company as in b) above just won a lawsuit that awards it $1 million immediately. If the original value of DGC company equity were $100 million, What would you guess was the rate of return of its stock now?
d) What would you answer be in question c)’s scenario if the market had expected DGC company to win $2 million?