Janet Ludlows firm requires all its analysts to use a twosta

Janet Ludlow’s firm requires all its analysts to use a two-stage DDM and the CAPM to value stocks. Using these measures, Ludlow has valued QuickBrush Company at $63 per share. She now must value SmileWhite Corporation.

a. Calculate the required rate of return for SmileWhite using the information in the following table:

                                                                            December 2010

Note: Risk-free rate = 3.5%; expected market return = 15.5%.

Instruction: enter your answer as a percentage rounded to 1 decimal place.

Required rate of return %

b. Ludlow estimates the following EPS and dividend growth rate for SmileWhite:

Estimate the intrinsic value of SmileWhite in December 2010 using the table above and the two-stage DDM. Dividends per share in 2010 were $1.

Instruction: enter your answer as a decimal number rounded to 2 decimal places.

Year      Dividends

2010       $1.00

2011       $

2012       $

2013       $

2014       $

Intrinsic stock value in 2013:     $.

Intrinsic stock value in 2010:     $.

Solution

a. required rate of return = risk free rate + Beta*(expected market return - risk free rate)

= 3.5% + 1.1*(15.5%-3.5%)

= 3.5% +1.1*12%

= 16.7%

b.

Present value of dividends in years from 2011 to 2013

Year PV of dividends

2011 1.15/1.167^1=0.985

2012 1.32/1.167^2 = 0.969

2013 1.52/1.167^3 = 0.956

total = $2.91

P(2013) = P(2014) / (r-g) = 1.72 / (0.167 - 0.13) = 46.49

PV(2010) of P 2013 = 46.49 / 1.167^3 = $29.25

Intrinsic value in 2010 = 2.91+29.25 = $32.16