Analyst Debra Williams must decide whether to invest in one of two stocks (A and B). Both
Question:
Analyst Debra Williams must decide whether to invest in one of two stocks (A and B). Both A and B are trading at $100 per share.
Her forecasts for company A as of the beginning of 2016 are the following:
Assume Terminal growth in perpetuity 3.5%; cost of capital 9%; 10 million shares outstanding.
Forecast ($ millions) | 2016 | 2017 | Terminal Value |
Net Income | 100 | 108 | 113 |
Dividend | 10 | 11 | 13 |
Beginning Book Value of Equity | 900 | ||
Residual NI | |||
Discount Factors: | 1 | 2 | 3 |
Present Value of $1 at 9% | 0.917 | 0.842 | 0.772 |
(a) Based on the assumptions above, what is the intrinsic value of A's stock at the beginning of 2016?
Williams estimates that company B has reached its steady state. The beginning book value of equity is 100 per share; current ROE is 9%; cost of capital 9%; and perpetual growth is expected to be 3.5%.
(b) Based on the assumptions above, what is the intrinsic value of B's stock?
(c) Which stock should Williams buy? Why?
Fundamentals of Financial Management
ISBN: 978-0324597707
12th edition
Authors: Eugene F. Brigham, Joel F. Houston