Week 2 – Assignment - Abbott Laboratories Problem
BUS405: Principles of Investments
Ashford University
Abbott Laboratories Problem
After understanding the Value Line figures and material on Abbott Laboratories in
the Questions and Problems section of Chapter 6 (just before Problem 27), finish Problems
27, 28, 29, 30, and 31 and submit to your instructor. Display the computations and in your
answer to problem 31, write a 100 to 200 word defense of your position as to the value of
Abbott Laboratories stock at its present cost of $50 per share.
27. What is the sustainable growth rate and required return for Abbott Laboratories?
Using these values, calculate the 2010 share price of Abbott Laboratories Industries stock
according to the constant dividend growth model.
Values:
Beta =
.60
Risk free rate =
3.13%
Market risk premium =
7%
Dividend declared per share =
$1.60
2009 EPS =
$3.65
2009 ROE =
28.00%
Beta
b = 1 – ($1.60 / $3.65) = .5616
Growth
g = 28% × .5616 = 15.73%
Risk adj. discount rate
k = 3.13% + 0.60(7%) = 7.33%
Present Value of divided stream P0 = $1.60(1 + .1573)2 / (.0733 – .1573) = ($25.52)
Note: I am unable to utilize the dividend growth model for my computations because
the required return of $25.52 is lower than the growth rate of 15.73%. In addition, I
squared the growth rate because the 2009 dividend is being utilized (although in reality
the 2011 dividend is required) to find for the 2010 price of stock.
28. Using the P/E, P/CF, and P/S ratios, estimates the 2010 share price for Abbott
Laboratories. Use the average stock price each year to calculate the price ratios.
Averages
P/E
CF
P/S
$17.08
$12.24
2.912
$3.65
$4.95
$19.70
Growth Rate
10.16%
9.82%
8.17%
Expected Stock
$68.68
$66.53
$62.06
5 Year Average
Price Ratio
Current Value
Per Share
Price
Calculation of
Expected Stock
17.08(1.1016)($3.65) 12.24(1.0982)($4.95) 2.912(1.0817)($19.70)
= $68.68
= $66.53
Price
Calculations of Average stock price and Growth rates:
Average Stock
Price
= $62.06
2005
2006
2007
2008
2009
High
$50.00
$49.90
$59.50
$61.10
$57.40
Low
37.50
39.20
48.80
45.80
41.30
Calculations
87.5/2 89.10/2 108.30/2
106.90/2
98.70/2
Total
43.75
44.55
54.15
53.45
49.35
43.75
44.55
54.15
53.45
49.35
2.5
2.52
2.84
3.03
3.65
$17.50
$17.68
$19.07
$17.64
$13.52
43.75
44.55
54.15
53.45
49.35
Average EPS
Averaged Stock
Price
EPS (divided by)
EPS
Average EPS =
$17.08
(85.41/5)
Average CFPS
Averaged Stock
Price
CFPS (divided by)
3.42
3.51
4.05
4.32
4.95
CFPS
12.79
12.69
13.37
12.37
9.97
Average Stock Price
43.75
44.55
54.15
53.45
49.35
SPS (divided by)
14.51
14.62
16.72
19.40
19.70
P/S
3.0151
3.0471
3.2386
2.7551
2.505
Average CFPS =
12.24
(61.19/5=12.238)
Average P/S
Average P/S =
2.912
(14.5609/5 =
2.9121)
Growth Rates
EPS Growth Rate
EPS
Growth Rate
Calculation
Divided
by
2009
3.65
20.46%
(3.65-3.03)
3.03
2008
3.03
6.69%
(3.03-2.84)
2.84
2007
2.84
12.7%
(2.84-2.52)
2.52
2006
2.52
.8%
(2.52-2.50)
2.50
2005
2.50
Growth Rate
Calculation
Divided
Total AVG EPS Growth Rate =
10.16%
(40.65%/4)
CF Growth Rate
CF
by
2009
4.95
14.58%
(4.95 - 4.32)
4.32
2008
4.32
6.67%
(4.32 - 4.05)
4.05
2007
4.05
15.38%
(4.05 - 3.51)
3.51
2006
3.51
2.63%
(3.51 - 3.42)
3.42
2005
3.42
Growth Rate
Calculation
Divided
Total AVG CF Growth Rate =
9.82%
(39.26%/4)
SPS Growth Rate
SPS
by
2009
19.70
1.55%
(19.70 -
19.40
19.40)
2008
19.40
16.03%
(19.40 -
16.72
16.72)
2007
16.72
14.36%
(16.72 -
14.62
14.62)
2006
14.62
.16%
(14.62 -
14.51
14.51)
2005
14.51
Total AVG SPS Growth Rate =
8.17%
(32.70%/4)
29. Assume the sustainable growth rate and required return you calculated in Problem
27 are valid. Use the clean surplus relationship to calculate the share price for Abbott
Laboratories with the residual income model.
EPS next year = $3.65 * 1.1573 = $4.22
Book value next year = $12.95 * 1.1573 = $14.99
P0 = $12.95 + {$4.22– ($12.95 * .0733)}/(0.0733 – 0.1573) = ($26.05)
30. Use the information from the previous problem and calculate the stock price with
the clean surplus dividend. Do you get the same stock price as in the previous problem?
Why or why not?
Clean dividend = $4.22 – ($14.99 – 12.95) = $2.18
P0 = $2.18 / (.0733 – .1573) = ($25.95)
The stock price calculated is different from the last problem because the ROE with the
help of book value is computed through the information that the organization has provided.
The clean surplus dividend on the other hand, permits us to form our own owner’s equity
and estimate the true REO and then assess the actual operating efficiency of Abbott
Laboratories.
31. Given your answers in the previous questions, do you feel Abbott Laboratories is
overvalued or undervalued at its current price of around $50? At what price do you feel the
stock should sell?
Through my evaluation I have observed that Abbott Laboratories is indeed
undervalued. My ratios clearly display that the P/E price is $68.68, P/CF price is $66.53,
and P/S price is $62.06. Due to these ratios, the stock should cost an average price of
{(68.68+66.53+62.06)/ (3)} = $65.76. The present cost of $50.00 is quite absurd for the
stock price. Furthermore, I have seen through my computations that it is not possible to
use the constant perpetual growth model or RIM model because the growth rate is
constantly higher than the required return. In closing, an investor usually purchases stocks
like this one because they have a great possibility of providing profit due to their
undervalued state.
Reference
Jordan, B., Miller, T., & Dolvin, S. (2012). Fundamentals of investments, valuation and
management (6th ed.). New York, NY: McGraw-Hill.