Copyright

Maxim Inc. reported a per-share book value of $10.47 in its balance sheet on December 31, 2014....

Question:

Maxim Inc. reported a per-share book value of $10.47 in its balance sheet on December 31, 2014. In early 2015, analysts were forecasting consensus earnings per share of $1.71 for 2015 and 1.96 for 2016.

Assume a dividend payout ratio of 50% and the required rate of return of 10%.

(a) Calculate the per share value in early 2015 assuming that residual earnings will grow at a long-term growth rate of 4%, the average GDP growth rate, after 2016.

(b) Maxim Inc. was traded at $36 per share in early 2015. What is the forecast of the residual earnings growth rate after 2016 that is implied in the stock price of $36?

Dividend Discount Model:

This model is useful in determining the intrinsic value of the common stock. According to this method, the stock value could be calculated by discounting future dividends using the required rate of return.

Answer and Explanation:

(a)

{eq}Price \ of \ share \ = \ Dividend \ \times \ \dfrac{\left ( 1 \ + \ g \right )}{\left ( k \ - \ g \right )} {/eq}

g = 4%

k = 10%

Dividend = EPS * Dividend payout

Dividend = 1.71 * 50%

Dividend = 0.855


{eq}Price \ = \ \dfrac{0.855 \ \times \ \left ( 1 \ + \ 4\% \right )}{\left ( 10\% \ - \ 4\% \right )} \\ Price \ = \ \$14.82 {/eq}


(b)

Stock price = $36

{eq}36 \ = \ 1.96 \ \times \ 0.5 \ \times \ \dfrac{\left ( 1 \ + \ g \right )}{\left ( 10\% \ - \ g \right )} \\ g \ = \ 7.08\% {/eq}


Learn more about this topic:

Loading...
The Dividend Growth Model

from Finance 101: Principles of Finance

Chapter 14 / Lesson 3
9.8K

Related to this Question

Explore our homework questions and answers library