Question: Assumeyou’ve generated the following information…
Assumeyou’ve generated the following information about the stock ofBufford’s BurgerBarns: TheCompany’s latest dividends of
$4.05
A share are expected to grow to
$4.41
Nextyear, to
$4.81
The year afterthat, and to
$5.24
In year 3. Afterthat, you think dividends will grow at a constant
6% rate.
- Use the variable growth version of the dividend valuation model and a required return of
15%
To find the value of the stock.
- Suppose you plan to hold the stock for threeyears, selling it immediately after receiving the
$5.24
Dividend. What is thestock’s expected selling price at thattime? As in part
(a) Assume a required return of
15%.
- Imagine that you buy the stock today paying a price equal to the value that you calculated in part
(a).You hold the stock for threeyears, receiving dividends as described above. Immediately after receiving the thirddividend, you sell the stock at the price calculated in part
(b).Use the IRR approach to calculate the expected return on the stock over three years. Could you have guessed what the answer would be before doing thecalculation?
- Suppose thestock’s current market price is actually
$50.25
Based on your analysis from part
(a), is the stock overvalued orundervalued?
- A friend of yours agrees with your projections ofBufford’s future dividends, but he believes that in threeyears, just after the company pays the
$5.24 dividend, the stock will be selling in the market for
$56.79 given thatbelief, along with thestock’s current market price from part
(d), Calculate the return that your friend expects to earn on the stock over the next three years.
