BAII Calculation DDM (Supernormal Growth)

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Reineir

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Hey Guys,
Please could someone be so kind as to provide the calculator workings for the following problem, this seems like a rather timely problem, do you recon that they would include this in the exam?
An analyst gathered the following information about a company:
The stock is currently trading at $31.00 per share.
Estimated growth rate for the next three years is 25%.
Beginning in the year 4, the growth rate is expected to decline and stabilize at 8%.
The required return for this type of company is estimated at 15%.
The dividend in year 1 is estimated at $2.00.
The stock is undervalued by approximately:
A) $6.40.
B) $0.00.
C) $15.70.
D) $2.30.
 
1) estimate terminal value using Gordon formula
2) use CF feature to calculate PV of CF (dividends and terminal value)
 
The value of stock today is :-
PY of Year 1 + PY of Year 2 + PV of Year 3 + PV of Price in Year 3
=> 2 / {(1.15)^1} + 2(1.25) / {(1.15)^2} + 2(1.25)(1.25) / {(1.15)^3}
+ { 2[(1.25)^2](1.08) / (.15-.08)} / {(1.15)^3}
=> 1.739130 + 1.890359 + 2.054738 + 31.701675
=> $37.385902
So the Stock is undervalued by = ( $$37.385902 - $31) = $ 6.385902
The Answer should be “A”
Is it right ?????
 
Alright so there would be no short cut , to work out this problem on your calculator.
I’m sorry Bee i haven;t yet worked it out.
 
I get A
Div1 2.00
Div2 2.5
Div3 3.125
Div4 3.375 (growth at 8%)
terminal value
3.375(1.08) / .15-.08
discounted back at 15% = 37.40
- stock price of 31 = 6.4 undervalued.
 
it really doesn’t take very long to do. just figure out your div’s by using relevant growth rates. term value is final div(1+term growth rate) /k-g. add that term value to your prior period div and plug in the CF function.
takes about 2 min i’d say after practicing a few times.
 
use the 2nd CF function
CF0=0
CF1=2.00 F1=1
CF2=2.5 F2=1
CF3=3.124 F3=1
CF4=3.375+37.40 F4=1
NPV
I=15
CPT NPV
 
CPK123,
I see that the princple is correct, but i dont seem to get the same values…..
I get NPV 28.99 ?
 
CF0=0
CF1=2.00 F1=1
CF2=2.5 F2=1
CF3=3.124 F3=1
CF4=3.375+ D4 / (ke – g) = $3.38 / (0.15 – 0.08) = $48.29
I=15%
Gives me NPV $35.23 ? ?
 
your Div4 is off. Div 4 should be Div 3 * 1+terminal growth rate.
so 3.375*1.08 = 3.645.
then to calculate terminal value it is 3.645/k-g so 3.645/.07 = 52.07
Then CF4 is 52.07 + 3.375
 
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