Imelda Emma, a financial analyst at Del Advisors, Inc. (DAI), has been asked to assess the impact that the construction of a new Disney theme park might have on its stock. DAI uses a dividend discount valuation model that incorporates beta in the derivation of risk-adjusted required rates of return on stocks.

             Until now Emma has been using five-year earnings and dividends per share growth rate of 15% and a beta estimate of 1.00 for Disney. Taking construction of the new theme park into account, however, she has raised her growth rate and beta estimates to 25% and 1.15, respectively. The complete set of Emma’s current assumptions is:

 

a. Calculate the risk-adjusted required rate of return on Disney stock using Emma’s current beta assumption.

b. Using the results of part (a), Emma’s current assumptions, and DAI’s dividend discount model, calculate the intrinsic value of Disney stock.

c. After calculating the intrinsic value of Disney stock using her new assumptions and DAI’s dividend discount model, Emma finds her recommendation for Disney should be changed from a “buy” to a “sell.” Explain how the construction of the new theme park could have such a negative impact on the valuation of Disney stock, despite Emma’s assumption of sharply higher growth rates (25%).

Transcribed Image Text:

$37.75 1.15 4.0% 10.0% 25.0% Current stock price Beta Risk-free rate of return (T-bill) Required rate of return on the market Short-term growth rate (five years) for earnings and dividends Long-term growth rate (beyond five years) for earnings and dividends Dividend forecast for coming year (per share) 9.3% $. 287 $37.75 1.15 4.0% 10.0% 25.0% Current stock price Beta Risk-free rate of return (T-bill) Required rate of return on the market Short-term growth rate (five years) for earnings and dividends Long-term growth rate (beyond five years) for earnings and dividends Dividend forecast for coming year (per share) 9.3% $. 287