Given the following estimated financial results, value the stock of Magic Holdings, Inc. using the infinite period dividend discount model (DDM).
Which of the following choices is closest to the value of Magic Holding Inc. stock? (Note: Carry calculations out to at least 3 decimals.)
Click on the arrows to vote for the correct answer
A. B. C. D.D
Here, we are given all the inputs we need. Use the following steps to calculate the value of the stock:
First, expand the infinite period DDM:
DDMformula: P0= D1/ (ke"" g)
D1 -
= (Earnings * Payout ratio) / average number of shares outstanding
= ($200,000 * 0.625) / 50,000 = $2.50.
ke
= nominal risk free rate + [beta * (expected market return "" nominal risk free rate)]
Note: Nominal risk-free rate = (1 + real risk free rate) * (1 + expected inflation) "" 1
=(1.035)*(1.040) "" 1 = 0.0764, or 7.64%.
ke
= 7.64% + [1.8 * (13.0% - 7.64%)] = 0.17288.
g
= (retention rate * ROE)
Retention = (1 "" Payout) = 1 "" 0.625 = 0.375.
ROE = (net income/sales)*(sales/total assets)*(total assets/equity)
= (200,000/1,000,000)*(1,000,000/750,000)*(750,000/500,000) = 0.40 g
= 0.375 * 0.40 = 0.15.
Then, calculate:P0= D1/ (ke"" g) = $2.50 / (0.17288 - 0.15) = 109.27.