An analyst with Churn Brothers is examining shares of Microscam International, a multinational software firm, for possible investment. Shares of Microscam are anticipated to grow at a rate of 20% per year for the next two years, then grow at 15% in the third year. Thereafter, the growth rate of Microscam International is expected to be at 11% per year forever. Similar investments have warranted a 15% per year rate of return, and Microscam paid a dividend of $0.50 at t0.
Using this information, what is the value of Microscam International common stock? Use the two-stage dividend discount model.
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A. B. C. D. E. F.Explanation
The multi-stage dividend discount model is a more realistic way of valuing fast-growing companies that pay dividends. With this model, it is necessary to estimate the above-average, or "supernormal" rate of growth, as well as the long-term rate of growth. Once these growth rates have been determined, they are used to calculate the dividends at various points in the future. In this example, you are provided with two supernormal growth rates, in addition to the long-term rate of growth, and the calculation is somewhat more complex than a situation characterized by a single supernormal growth rate. Nonetheless, the multistage dividend discount model can be applied.
The multi-stage dividend discount model is often referred to as the "two-stage dividend discount model," and these two titles should be considered interchangeable for all intents and purposes, i.e. the "two stage" dividend discount model can be used to determine the value of a company that has multiple growth rate changes.
Incorporating the given information into the multi-stage dividend discount model will yield the following:
P = {[$0.50 * 1.20) / 1.15] + [($0.60 * 1.20) / 1.3225] + [($0.72 * 1.15) / 1.52087] + [($0.828 * 1.11) / (.15 -
11)]/1.52087}
which can further be developed into:
P = {$0.52174 + $0.54442 + $0.54442 + $15.11} = $16.72