7-1: Price, Growth & Return: Solution
7-1: Price, Growth & Return: Solution
7-1: Price, Growth & Return: Solution
Superior Logistics Ltd. had given a dividend of Rs 4.00. According to the analysts in the logistic
industry the growth rate of dividend is expected to be 8% for times to come. If the market
expectation of return is 14% what should be the price of the stock of Superior Logistics?
Also project the price of the stock after one year and verify whether the shareholder gets
return of 14%.
Solution:
Current dividend, D0 Rs 4.00
Growth in dividend, g 8.00%
Required return, r 14.00%
Solution:
Compounded annual growth rate of dividend can be found using following
equation:
D8 3
(1+ g)8 = = =3
D1 1
g = 0.1472 = 14.72%
Solution
If the growth rate is revised to 18% the new price as per DDM would be:
Current dividend, D0 Rs 3.00
Growth in dividend, g 18.00%
Required return, r 20.00%
Solution:
The return expected by the market can be arrived using DDM for stock value as
below:
Do(1+ g)
Value of the Stock, Po =
r-g
D1
or r-g=
P0
D1
r= +g
P0
Solution:
The value of the stock is governed by following equation
D o(1+ g)
Value of the Stock, P o =
r-g
2.40(1+ g)
32.10 =
0.15 g
Gives = 0.07 = 7%
With growth rate of 7% the price expected after 3 years would be
P3 = P0 x (1 + g)3 = 32.10 x 1.073 = Rs 39.32
The expected return of the investor buying today and selling three years later would
be 15% as can be confirmed by following cash flows
Figures in Rs
Year 0 1 2 3
Buy stock -32.10 - - -
Dividend - 2.57 2.75 2.94
Sell Stock 39.32
Cash flow -32.10 2.57 2.75 42.26
IRR of cash flow = Return for investor = 15.00%
Solution:
Current dividend Rs 2.00
Growth rate for 4 years 15%
Required rate of return 16%
Present value of dividends for next four years:
Year 1 2 3 4
Dividend, Rs 2.30 2.65 3.04 3.50
PV at 20%, Rs 1.98 1.97 1.95 1.93
PV of Dividends from Year 1 - 4 7.83
Solution:
Under the present scenario the stock price is Rs 72.00 as worked out below:
After the announcement of development of new chip the next dividend pay out is in
Year 3.
With revised parameters of dividend and growth the price is worked out for Year 3
and then discounted back to present.
Dividend in Year 3, D3 Rs 5.00
Growth in dividend, g 10.00%
Required return, r 14.00%
Solution:
The dividend discount model in terms of earnings and retention ratio is
D1 E x (1 b)
Price, P 1
0 (r g) (r g)
Solution:
The price in terms of earnings and retention is Rs 35.67 as shown below:
Current Earnings, E0 Rs 4.04
Growth Rate, g 3.00%
Required Return, r 0.1
Expected Earnings, E1 Rs 4.16
Retention Ratio, b 40%
With revised and increased estimates of growth the PE multiple would rise.
Current Earnings, E0 Rs 4.04
Growth Rate, g 6.00%
Required Return, r 10%
Expected Earnings, E1 Rs 4.28
Retention Ratio, b 40%