AMAL MOBARAKI 441212274

Part I

1. Mohan Gupta is the portfolio manager of an India - based equity fund. He is analyzing the value
of Tata Chemicals Ltd. (Bombay Stock Exchange: TATACHEM). Tata Chemicals is India’s leading
manufacturer of inorganic chemicals, and also manufactures fertilizers and food additives. Gupta
has concluded that the DDM is appropriate to value Tata Chemicals. During the past five years
(fiscal year ending 31 March 2004 to fiscal year ending 31 March 2008), the company has paid
dividends per share of Rs.5.50, 6.50, 7.00, 8.00, and 9.00, respectively. These dividends suggest
an average annual growth rate in DPS of just above 13 percent. Gupta has decided to use a three
- stage DDM with a linearly declining growth rate in stage 2. He considers Tata Chemicals to be
an average growth company, and estimates stage 1 (the growth stage) to be 6 years and stage 2
(the transition stage) to be 10 years. He estimates the growth rate to be 14 percent in stage 1
and 10 percent in stage 3. Gupta has estimated the required return on equity for Tata Chemicals
to be 16 percent. Estimate the current value of the stock.
D0 9
gS 14% for 6 years
gL 10%
Period over which dividend growth of 14% declines linearly is 10 years
R 16%

To estimate the current value of the stock using the three-stage Dividend Discount Model (DDM),
we need to calculate the present value of the dividends for each stage and sum them up.

Let's break down the calculation step by step:

1. Calculate the dividends for each stage:

Stage 1 (growth stage): The current dividend (D0) is given as Rs. 9. The growth rate (gS) during
this stage is 14% for 6 years. We can use this information to calculate the dividends for each year
during this stage.

Year 1 dividend (D1) = D0 * (1 + gS) = 9 * (1 + 0.14) = Rs. 10.26

Year 2 dividend (D2) = D1 * (1 + gS) = 10.26 * (1 + 0.14) = Rs. 11.70
Year 3 dividend (D3) = D2 * (1 + gS) = 11.70 * (1 + 0.14) = Rs. 13.34
Year 4 dividend (D4) = D3 * (1 + gS) = 13.34 * (1 + 0.14) = Rs. 15.21
Year 5 dividend (D5) = D4 * (1 + gS) = 15.21 * (1 + 0.14) = Rs. 17.35
Year 6 dividend (D6) = D5 * (1 + gS) = 17.35 * (1 + 0.14) = Rs. 19.75
 Stage 2 (transition stage): The dividend growth rate (gS) declines linearly over 10 years. We
already have the dividend for year 6 (D6). We need to calculate the dividends for years 7 to 16.

The decline in growth rate per year is (gS - gL) / (10 - 6) = (0.14 - 0.10) / 4 = 0.01

Year 7 dividend (D7) = D6 * (1 + gL - 0.01) = 19.75 * (1 + 0.10 - 0.01) = Rs. 21.57

Year 8 dividend (D8) = D7 * (1 + gL - 0.02) = 21.57 * (1 + 0.10 - 0.02) = Rs. 23.42
Year 9 dividend (D9) = D8 * (1 + gL - 0.03) = 23.42 * (1 + 0.10 - 0.03) = Rs. 25.41
Year 10 dividend (D10) = D9 * (1 + gL - 0.04) = 25.41 * (1 + 0.10 - 0.04) = Rs. 27.55
Year 11 dividend (D11) = D10 * (1 + gL - 0.05) = 27.55 * (1 + 0.10 - 0.05) = Rs. 29.84
Year 12 dividend (D12) = D11 * (1 + gL - 0.06) = 29.84 * (1 + 0.10 - 0.06) = Rs. 32.28
Year 13 dividend (D13) = D12 * (1 + gL - 0.07) = 32.28 * (1 + 0.10 - 0.07) = Rs. 34.89
Year 14 dividend (D14) = D13 * (1 + gL - 0.08) = 34.89 * (1 + 0.10 - 0.08) = Rs. 37.67
Year 15 dividend (D15) = D14 * (1 + gL - 0.09) = 37.67 * (1 + 0.10 - 0.09) = Rs. 40.64
Year 16 dividend (D16) = D15 * (1 + gL - 0.10) = 40.64 * (1 + 0.10 - 0.10) = Rs. 40.64 (last year's
dividend)

2. Calculate the present value of each dividend:

We need to discount each dividend back to the present value using the required return on
equity (R) of 16%.

Present value of D1 = D1 / (1 + R) = 10.26* (1 + 0.16) = Rs. 8.85

Present value of D2 = D2 / (1 + R)^2 = 11.70 * (1 + 0.16)^-2 = Rs. 8.14
Present value of D3 = D3 / (1 + R)^3 = 13.34 * (1 + 0.16)^-3 = Rs. 7.12
Present value of D4 = D4 / (1 + R)^4 = 15.21 * (1 + 0.16)^-4 = Rs. 6.20
Present value of D5 = D5 / (1 + R)^5 = 17.35 * (1 + 0.16)^-5 = Rs. 5.40
Present value of D6 = D6 / (1 + R)^6 = 19.75 * (1 + 0.16)^-6 = Rs. 4.70
Present value of D7 = D7 / (1 + R)^7 = 21.57 * (1 + 0.16)^-7 = Rs. 4.08
Present value of D8 = D8 / (1 + R)^8 = 23.42 * (1 + 0.16)^-8 = Rs. 3.55
Present value of D9 = D9 / (1 + R)^9 = 25.41 * (1 + 0.16)^-9 = Rs. 3.08
Present value of D10 = D10 / (1 + R)^10 = 27.55 * (1 + 0.16)^-10 = Rs. 2.67
Present value of D11 = D11 / (1 + R)^11 = 29.84 * (1 + 0.16)^-11 = Rs. 2.31
Present value of D12 = D12 / (1 + R)^12 = 32.28 * (1 + 0.16)^-12 = Rs. 2.00
Present value of D13 = D13 / (1 + R)^13 = 34.89 * (1 + 0.16)^-13 = Rs. 1.73
Present value of D14 = D14 / (1 + R)^14 = 37.67 * (1 + 0.16)^-14 = Rs. 1.50
Present value of D15 = D15 / (1 + R)^15 = 40.64 * (1 + 0.16)^-15 = Rs. 1.30
Present value of D16 = D16 / (1 + R)^16 = 40.64 * (1 + 0.16)^-16 = Rs. 1.13

3. Calculate the sum of the present values of dividends:

Sum = Present value of D1 + Present value of D2 + ... + Present value of D16

Sum = 8.85 + 8.14 + 7.12 + 6.20 + 5.40 + 4.70 + 4.08 + 3.55 + 3.08 + 2.67 + 2.31 + 2.00 + 1.73 +
1.50 + 1.30 + 1.13
= Rs. 73.26
The estimated current value of the stock, based on the three-stage DDM, is approximately Rs.
73.26.

2. You are analyzing the stock of Ansell Limited (Australian Stock Exchange: ANN), a health care
company, as of late June 2008. The stock price is $9.74. The company’s dividend per share for
the fiscal year ending 31 June 2008 was $0.27. You expect the dividend to increase by 10 percent
for the next three years and then increase by 8 percent per year forever. You estimate the
required return on equity of Ansell Limited to be 12 percent.
(i) Estimate the value of ANN using a two-stage dividend discount model.
(ii) Judge whether ANN is undervalued, fairly valued, or overvalued.

2008 2009 2010 2011 2012

0 1 2 3 4
Dividend growth 10% 10% 10% 8%

To estimate the value of ANN using a two-stage dividend discount model, we need to calculate
the present value of the dividends for each stage and sum them up.

Given information:
- Stock price (P0) = $9.74
- Dividend per share for fiscal year ending 31 June 2008 (D0) = $0.27
- Dividend growth rate for the next three years (g1) = 10%
- Dividend growth rate from year 4 onwards (g2) = 8%
- Required return on equity (R) = 12%

(i) Calculation of the value of ANN using a two-stage dividend discount model:

1. Calculate the dividends for each year:

Year 1 dividend (D1) = D0 * (1 + g1) = $0.27 * (1 + 0.10) = $0.297
Year 2 dividend (D2) = D1 * (1 + g1) = $0.297 * (1 + 0.10) = $0.3267
Year 3 dividend (D3) = D2 * (1 + g1) = $0.3267 * (1 + 0.10) = $0.35937
Year 4 dividend (D4) = D3 * (1 + g2) = $0.35937 * (1 + 0.08) = $0.388496

2. Calculate the present value of each dividend:

 We need to discount each dividend back to the present value using the required return on
equity (R) of 12%.

Present value of D1 = D1 / (1 + R) = $0.297 / (1 + 0.12) = $0.265179

Present value of D2 = D2 / (1 + R)^2 = $0.3267 / (1 + 0.12)^2 = $0.263451
Present value of D3 = D3 / (1 + R)^3 = $0.35937 / (1 + 0.12)^3 = $0.282916
Present value of D4 = D4 / (1 + R)^4 = $0.388496 / (1 + 0.12)^4 = $0.281528

3. Calculate the sum of the present values of dividends:

Sum = Present value of D1 + Present value of D2 + Present value of D3 + Present value of D4

Sum = $0.265179 + $0.263451 + $0.282916 + $0.281528

= $1.093074

(ii) Determine the valuation of ANN:

To judge whether ANN is undervalued, fairly valued, or overvalued, we compare the calculated
value of ANN, which is $1.093074, with the current stock price of $9.74.

If the calculated value is higher than the stock price, it indicates that the stock may be
undervalued and could be a buying opportunity. However, if the calculated value is lower than
the stock price, it suggests that the stock may be overvalued and could be a selling opportunity.

In this case, since the calculated value ($1.093074) is significantly lower than the current stock
price ($9.74), we can conclude that ANN is overvalued.

3. Maspeth Robotics shares are currently selling for €24 and have paid a dividend of €1 per
share for the most recent year. The following additional information is given:
(i) The risk - free rate is 4 percent,
(ii) The shares have an estimated beta of 1.2, and
(iii) The equity risk premium is estimated at 5 percent.
Based on the above information, determine the constant dividend growth rate that would be
required to justify the market price of €24.

To determine the constant dividend growth rate (g) that would be required to justify the
market price of €24, we can use the Gordon Growth Model, also known as the Dividend
Discount Model (DDM). The formula for the Gordon Growth Model is as follows:

P0 = D1 / (r - g)

Where:
P0 = Current market price of the stock
D1 = Dividend expected to be paid at the end of the current year
r = Required rate of return
g = Constant dividend growth rate

Given information:
- Current market price (P0) = €24
- Dividend per share for the most recent year (D1) = €1
- Risk-free rate (rf) = 4%
- Estimated beta (β) = 1.2
- Equity risk premium (ERP) = 5%

To calculate the required rate of return (r), we use the Capital Asset Pricing Model (CAPM):

r = rf + β * ERP

r = 0.04 + 1.2 * 0.05

r = 0.04 + 0.06

r = 0.10 or 10%

Now, we can rearrange the Gordon Growth Model formula to solve for the constant dividend
growth rate (g):

g = r - (D1 / P0)

g = 0.10 - (€1 / €24)

g = 0.10 - 0.0417

g = 0.0583 or 5.83%
Therefore, the constant dividend growth rate required to justify the market price of €24 is
approximately 5.83%.

4. Hanson PLC (LSE:HNS) is selling for GBP472. Hansen has a beta of 0.83 against FTSE 100
index, and the current dividend is GBP 13.80. The risk free rate of return is 4.66%, the equity
risk premium is 4.92%. An analyst covering this stock expects the Hansen dividend to grow
initially at 14% but to decline linearly to 5% over a 10-year. After that, the analyst expects
dividends to grow at 5%.

(a) Compute the value of Hansen dividend stream using the H-model. According to the H-model
valuation, is Hansen overpriced or underpriced?

(b) Assume that Hansen’s dividends follow the H-model pattern the analyst predicts. If an
investor pays the current GBP 472 price for the stock, what will be the rate of return?

To compute the value of Hansen's dividend stream using the H-model, we need to calculate the
present value of dividends for each period and sum them up. The H-model is used to value
stocks with a high initial growth rate that declines linearly to a stable growth rate over time.

Given information:
- Current stock price (P0) = GBP 472
- Dividend per share (D0) = GBP 13.80
- Beta (β) = 0.83
- Risk-free rate (rf) = 4.66%
- Equity risk premium (ERP) = 4.92%
- Initial dividend growth rate (g1) = 14%
- Declining dividend growth rate (g2) = 5%
- Stable dividend growth rate (g3) = 5%
- Number of years of declining growth (n) = 10

(a) Calculation of Hansen's dividend stream using the H-model:

1. Calculate the required rate of return (r) using the Capital Asset Pricing Model (CAPM):
r = rf + β * ERP
r = 0.0466 + 0.83 * 0.0492
r = 0.0466 + 0.040716
r = 0.087316 or 8.7316%

2. Calculate the present value of dividends for each period:

Year 1 dividend (D1) = D0 * (1 + g1) = GBP 13.80 * (1 + 0.14) = GBP 15.732
Year 2 dividend (D2) = D1 * (1 + g2) = GBP 15.732 * (1 + (0.14 - 0.14) * (10 - 2) / 10) = GBP
15.732 * (1 + 0.07) = GBP 16.81944
Year 3 dividend (D3) = D2 * (1 + g2) = GBP 16.81944 * (1 + (0.14 - 0.14) * (10 - 3) / 10) = GBP
16.81944 * (1 + 0.04) = GBP 17.50798

For years 4 to 10, the dividend growth rate remains constant at g3 = 5%.
Year 4 dividend (D4) = D3 * (1 + g3) = GBP 17.50798 * (1 + 0.05) = GBP 18.38338
Year 5 dividend (D5) = D4 * (1 + g3) = GBP 18.38338 * (1 + 0.05) = GBP 19.30256
Year 6 dividend (D6) = D5 * (1 + g3) = GBP 19.30256 * (1 + 0.05) = GBP 20.26769
Year 7 dividend (D7) = D6 * (1 + g3) = GBP 20.26769 * (1 + 0.05) = GBP 21.27907
Year 8 dividend (D8) = D7 * (1 + g3) = GBP 21.27907 * (1 + 0.05) = GBP 22.33701
Year 9 dividend (D9) = D8 * (1 + g3) = GBP 22.33701 * (1 + 0.05) = GBP 23.44286
Year 10 dividend (D10) = D9 * (1 + g3) = GBP 23.44286 * (1 + 0.05) = GBP 24.598

3. Calculate the present value of each dividend:

 We need to discount each dividend back to the present value using the required rate of return
(r) of 8.7316%.

Present value of D1 = D1 / (1 + r) = GBP 15.732 / (1 + 0.087316) = GBP 14.46824

Present value of D2 = D2 / (1 + r)^2 = GBP 16.81944 / (1 + 0.087316)^2 = GBP 14.60878
Present value of D3 = D3 / (1 + r)^3 = GBP 17.50798 / (1 + 0.087316)^3 = GBP 14.74186
Present value of D4 = D4 / (1 + r)^4 = GBP 18.38338 / (1 + 0.087316)^4 = GBP 14.87202
Present value of D5 = D5 / (1 + r)^5 = GBP 19.30256 /Apologies for the incomplete response.
Let's continue with the calculations:

Present value of D5 = D5 / (1 + r)^5 = GBP 19.30256 / (1 + 0.087316)^5 = GBP 15.01835

Present value of D6 = D6 / (1 + r)^6 = GBP 20.26769 / (1 + 0.087316)^6 = GBP 15.14707
Present value of D7 = D7 / (1 + r)^7 = GBP 21.27907 / (1 + 0.087316)^7 = GBP 15.27370
Present value of D8 = D8 / (1 + r)^8 = GBP 22.33701 / (1 + 0.087316)^8 = GBP 15.39831
Present value of D9 = D9 / (1 + r)^9 = GBP 23.44286 / (1 + 0.087316)^9 = GBP 15.52094
Present value of D10 = D10 / (1 + r)^10 = GBP 24.598 / (1 + 0.087316)^10 = GBP 15.64161

4. Calculate the sum of the present values of dividends:

Sum = Present value of D1 + Present value of D2 + ... + Present value of D10

Sum = GBP 14.46824 + GBP 14.60878 + GBP 14.74186 + GBP 14.87202 + GBP 15.01835 + GBP
15.14707 + GBP 15.27370 + GBP 15.39831 + GBP 15.52094 + GBP 15.64161
= GBP 151.19098

(b) To calculate the rate of return, we can use the formula:

Rate of return = (Dividends received + Stock price at the end - Stock price at the beginning) /
Stock price at the beginning
In this case, the stock price at the beginning is GBP 472 (the current price).

To calculate the dividends received, we sum the dividends received over the 10-year period:
Dividends received = D1 + D2 + ... + D10

Dividends received = GBP 13.80 + GBP 15.732 + GBP 16.81944 + GBP 17.50798 + GBP 18.38338
+ GBP 19.30256 + GBP 20.26769 + GBP 21.27907 + GBP 22.33701 + GBP 23.44286
= GBP 187.67199

Now, let's calculate the rate of return:

Rate of return = (Dividends received + Stock price at the end - Stock price at the beginning) /
Stock price at the beginning

Rate of return = (GBP 187.67199 + GBP 472 - GBP 472) / GBP 472
= GBP 187.67199 / GBP 472
≈ 0.397 or 39.7%

Therefore, if an investor pays the current GBP 472 price for the stock and the dividends follow
the H-model pattern predicted by the analyst, the rate of return would be approximately
39.7%.
Part II
Fast Grow Corporation is expecting dividends to grow at a 20% rate for the next two years. The
corporation just paid a $2 dividend and the next dividend will be paid one year from now. After
two years of rapid growth dividends are expected to grow at a constant rate of 9% forever.
1. If the required return is 14%, what is the value of Fast Grow Corporation common stock
today?
a. $40.26
b. $46.70
c. $52.63
d. $42.38
2. Assume that the annual dividend grows at a constant rate of 9% indefinitely instead of the
supernormal growth. How much is the stock worth if dividends grow annually at 9%?
a. $40.00
b. $43.60
c. $45.60
d. $52.40
3. A company is currently paying no dividend and will not pay one for several years. If the
company starts paying dividend of $1.5 per share five years from now, and the dividend is
expected to grow at 5% thereafter. What is the value of the company’s stock per share today, if
your required rate of return is 11 per cent?
a $10.98
b. $16.47
c. $17.5
d. $9.09
4. The Babet Computer Corporation has been experiencing an above normal dividend growth
rate of 20% per year for the last 5 years. This above normal growth rate is expected to continue
for another 3 years before it levels off at a more normal rate of 6%. Babet’s last dividend was
$0.50 per share. Determine the current value of Babet’s stock if its required rate of return is 15%.
a. $8.33
b. $6.31
c. $9.60
d. $10.2
5. Your broker has advised you that he believes that the stock of Brat Inc. is going to rise from
$20 to $22.15 per share over the next year. You know that the annual return on the S&P 500
has been 11.25% and the 90-day T-bill rate has been yielding 4.75% per year over the past 10
years. If beta for Brat is 1.25, will you purchase the stock?
a. Yes, because it is overvalued
b. No, because it is overvalued
c. No, because it is undervalued
d. Yes, because it is undervalued
6. IBM currently pays a dividend of $0.55 per year, which is expected to grow at 7.5% for the next
two years and at 13.5% for the following four years and at 11.25% thereafter. What is the current
value of IBM stock, if your required rate of return is 12%?
a. $79,27
b. $82.40
c. $39.80
d. $19.97
7. You wish to value the stocks of Hormel Food, which is currently paying a dividend of $0.39.
This dividend is expected to grow at a rate of 12.5% annually for the next three years, and
afterwards the dividend growth rate will decline linearly from 12.5% to 6.75% over the next ten
years. If your required rate of return is 8.90%, what will be value of stock per share today?
a. $19.97
b. $28.35
c. $19.14
d. $21.51

USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)

The National Motor Company's last dividend was $1.25 and the directors expect to maintain
the historic 4 percent annual rate of growth. You plan to purchase the stock today because you
feel that the growth rate will increase to 7 percent for the next three years and the stock will
then reach $25.00 per share.
8. How much should you be willing to pay for the stock if you require a 16 percent return?
a. $17.34
b. $18.90
c. $19.09
d. $19.21
9. How much should you be willing to pay for the stock if you feel that the 7 percent growth
rate can be maintained indefinitely and you require a 16 percent return?
a. $11.15
b. $14.44
c. $14.86
d. $18.90