In the Section 3: Dividend Analysis and Preliminary Valuation assignment, you will compute the of the company’s stock value based on historical dividend data for your company and a market-based equity rate of return. In this analysis, you will use the constant growth formula to compute two estimates of the stock price, a high-end value and a low-end value. Analysts frequently assess the stock value using a range of values, based on reasonable assumptions for a high-end and a low-end range.
Once you have calculated two stock values, you will compare the company’s calculated values compared to the current market price of the stock. This comparison will help you determine if the stock is currently under-valued or over-valued, and will help you determine your recommendation of buy, hold, or sell. Analysts prepare value estimates based on historical data for the company as well as an understanding of expected future equity rates of return. It is important to understand that the constant growth formula provides an estimate of value, and analysts, like all humans, can be both right and wrong. The inputs used in the formula will greatly impact the value conclusion.
Prepare:
Prior to beginning work on this assignment,
BUS401 – Constant Growth Formula (Links to an external site.)
Write:
In your paper, address the following five parts in a Word document:
Part 1: Dividend Analysis (two to three paragraphs):
- Create a table that illustrates the annual dividends per share paid by your selected company over the past 10 years. If the company has not paid dividends for 10 years, include as many years as available.
- Calculate the growth in annual dividends per share each year and include this annual growth rate in your table.
- Calculate the average dividend growth rate over the following periods:
- the most recent 10 years,
- the most recent 5 years, and
- the most recent 3 years.
- Summarize the trend in the dividend growth rates.
- Have the dividend growth rates increased or decreased? By how much? Has the increase or decrease been steady or varied from year to year?
- Determine two distinct estimates of the future dividend growth rate for this company: a high-end growth rate and a low-end growth rate. You are to choose these growth rates based on what is reasonable from the data you have on the company’s dividend growth in prior years, as presented in your table. The two future dividend growth rates can be any of following:
- the most recent year growth rate;
- the average growth rate over the 10-year period;
- the average growth rate over the most recent 5 years;
- the average growth rate of the most recent 3 years; or
- a growth rate you select that is reasonable, given the 10-year, 5-year, and 3-year averages, as well as the recent year growth rates.
- NOTE: Both dividend growth rates must be lower than the required rate of return used in the constant growth formula. See Part 2 below for the required rate of return to use in the constant growth formula.
- Justify the determined the high-end dividend growth rate and low-end dividend growth rates for your company. In your justification, provide a least two financial facts from your Week 1 and Week 2 assignments to support your determination.
Part 2: Preliminary Valuation: (two to three paragraphs)
- Calculate the stock price for your selected company using the constant growth formula and the low-end dividend growth rate you determined in Part 1. Show all calculations for this estimated stock price using the low-end dividend growth rate.
- For the required rate of return (r), use the following assumptions:
- For a large capitalization company (greater than $10.0 billion in market capitalization) use 10.0%.
- For a mid-cap company (between $2.0 billion and $10.0 billion in market capitalization) use 12.0%.
- For a small-cap company (less than $2.0 billion in market capitalization) use 15.0%.
- Show your calculations.
- For the required rate of return (r), use the following assumptions:
- In a similar manner, calculate another estimate of the stock price for your selected company using the constant growth formula and the high-end dividend growth rate.
- Use the same assumptions for the required rate of return (r) that you used for the low-end stock price, other than using the high-end dividend growth rate.
- Show your calculations.
- Compare each of the two stock prices you just calculated to the current stock price per share of the company.
- State whether each constant growth stock price (low-end and high-end) is above or below the current price.
- State whether each constant growth stock price (low-end and high-end) indicates if the stock price is currently under-valued or over-valued in the market.
- Determine your concluded stock value, based on the two calculations using the constant growth formula.
- Justify your conclusion of value for your stock, using either the high-end stock price or the low-end stock price from the constant growth formula. Include least two financial facts from your Week 1 and Week 2 analyses.
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The Section 3: Dividend Analysis and Preliminary Valuation paper
Note: Since this is Section 3 of the Week 5 final project, there is no need for an introduction paragraph.
Carefully review the Grading Rubric (Links to an external site.) for the criteria that will be used to evaluate your assignment.
