Calculate the dividend/cash flow each year
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Chapter 9 Stocks:Show your steps either following the textbook guidelines for setting up these stock valuation problems or your own steps: If you follow the textbook Pages 275 – 278 it gives you’re the information to complete these three.
There are three steps:
1. Calculate the dividend/cash flow each year using the growth rate
2. Determine where the growth of the company becomes constant (this is the key constant growth rate model), this is called the terminal or horizon value.
3. Place each of these cash flows into the calculator or excel using the interest rate given and calculate NPV which is now called the intrinsic value. Note: The book examples do these the long way with formulas and math.
The trick with the Free cash flow questions (2 and 3) is to remember to divide your final answer by the number of shares to get the stock price otherwise known as the intrinsic value.
1. The earnings of Best Forecasting Company are expected to grow at an annual rate of 14% over the next 5 years and then slow to a constant rate of 10% per year. Best currently pays a dividend of $0.36 per share. What is the value of Best stock to an investor who requires a 16% rate of return? If stock has a market price of $15 do you buy?
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