Problem 6 (15 marks)

You are interested in determining the intrinsic value of Hoffman Inc.

Your analysis shows that the firms growth rate will drop from its current pace by 20% each of the next two years, and then you estimate that dividends will continue to grow at the year 2 rate, with the same dividend policy in place, indefinitely.

Lastly, your estimate of the required return on the firms equity is 12%.

Hoffmans recently published annual report shows the following financial relationships:

Assets = 1.4 x Equity

Current Assets = 1.7 x Current Liabilities

Sales = 1.5 x Assets

Net Income = 8% x Sales

Dividends = 30% x Net Income

Earnings per share (Basic) = $0.80 per share

Required:

• Determine the growth rate of the company for the prior and for each of the next two years.
• Use the multi-period DDM to estimate the intrinsic value of the companys stock now, at the beginning of year 1.
• If all of your expectations remain as shown, except that, on the last day of year 1, the required return decreases by 1%. What would be your holding period return for the year?