Ch
Question
16
Valuation of Stocks with Shifting Growth Rates (64.0K)
Click here to download the spreadsheet
The constant growth model may not apply to most stocks. Firms are often expected to
experience different rates of growth in earnings and dividends. For example, a firm may be
expecting a high rate of growth for the next five to ten years followed by lower or more normal
growth.
The accompanying spreadsheet allows you to estimate value for firms that do not fit the constant
growth model. The model is set up to allow you to specify one or two shifts in growth rates to be
followed by normal or constant growth. The models are built to allow you to use any growth rate
and duration of growth for the early stages of growth. Using the models can help understand
how growth affects value. The models also solve for price to earnings ratios to assess the impact
of differential growth on PE ratios.
Problems:
(Data for Questions 1-4)
Shares of Data View are currently selling at $20 per share. You have estimated the growth
opportunities for Data View and you believe that they will be able to grow at a rate of 30% for
the next 10 years. After that you estimate that their earnings growth will slow to a normal rate
of 15%. You estimate their beta coefficient to be 1.75. The current risk-free rate is 4% and you
estimate the appropriate market risk premium to be 8%.
1. Should you buy the stock? Compare the intrinsic value based on your estimates to the
market price.
2. How much of your intrinsic value is attributable to growth opportunities?
3. What is the PE Ratio for current and next year’s earnings based on your intrinsic value?
4. Perform a two-way sensitivity analysis for the stock price that allows the duration of first
growth to vary from 6 to 20 years in increments of 2 years and allows the duration of
first stage growth to vary from 20 to 40 percent in increments of 5 percent. Complete a
similar table for the price to next year’s expected earnings ratio.
(Data for Questions 5-8)
Data Connect is a fast growing company with tremendous growth opportunities. The stock is
currently selling at $15 per share. You are considering the purchase of the company. You
estimate from your analysis that companies earning of $0.30 per share and dividends of $0.05
per share will be able to grow at 50% for the next 8 years. You then anticipate the company will
be able to grow at a rate of 30% for an additional 10 years before settling down to a normal
constant rate of growth of 15%. You estimate the beta coefficient to be 1.8 and the market risk
premium to be 10%. The current T-bill rate is 4%.
5. Should you buy the stock? Compare the intrinsic value based on your estimates to the
market price.
6. How much of your intrinsic value is attributable to growth opportunities?
7. What is the PE Ratio for current and next year’s earnings based on your intrinsic value?
8. Perform a two-way sensitivity analysis for the stock price that allows the market risk
premium to vary from 8% to 13% in increments of one percent and allows the beta
coefficient to vary from 1.5 to 2.1 in increments of 0.1. Complete a similar table for the
price to next year’s expected earnings ratio.