Janet Ludlow’s firm requires all its analysts to use a two-stage dividend discount model (DDM) and the Capital Asset Pricing Model (CAPM) to value stocks. Using the CAPM and DDM, Ludlow has valued QuickBrush Company at $63 per share. She now must value SmileWhite Corporation.
a. Calculate the required rate of return for SmileWhite using the information in the following table:
|
QuickBrush |
SmileWhite |
|
|
Beta |
1.35 |
1.15 |
|
Market price |
$45.00 |
$30.00 |
|
Intrinsic value |
$63.00 |
? |
|
Notes: |
||
|
Risk-free rate |
4.50% |
|
|
Expected market return |
14.50% |
|
b. Ludlow estimates the following EPS and dividend growth rates for SmileWhite:
|
First three years: |
12% per year |
|
Years thereafter: |
9% per year |
Estimate the 1999 intrinsic value of SmileWhite using the table above, and the twostage DDM. Dividends per share in 1999 were $1.72.
c. Recommend QuickBrush or SmileWhite stock for purchase by comparing each company’s intrinsic value with its current market price.
d. Describe one strength of the two-stage DDM in comparison with the constantgrowth DDM. Describe one weakness inherent in all DDMs.