FIRE 311 - Chapter 7 Groupwork PDF

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Chapter 7 (Dividend Discount Models) Class Group-work assignment for professor Miroslava...

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In -class work and group assignment related to Chapter 7 311, Spring 2020

FIRE

ZOOM Class date: March 25, 2020 Prerequisites: Basic knowledge from Chapter 7

Group Assignment: Submit solutions to problems 1, 2, and 3 to the Blackboard by Sunday. Problem 1: Stock Quotes Go to: https://www.cnbc.com/quotes/?symbol=jwn&qsearchterm=jwn to retrieve a quote for the common stock of Nordstrom. Answer the following questions: 1.

What is the ticker symbol for the stock? At what exchange does the stock trade? ● ●

2.

NYSE

What is the latest price for the stock and what is the 52-dange in stock price? ● ●

18.25 52 week range: 14.06- 46.20

3. What is the market capitalization of the company? Verify from the data that you can find in the quote that market capitalization = stock price x number of shares outstanding. ●

Market Cap: 2.9 billion = 156.3M x 18.25

4. What was the latest quarterly dividend per share paid? What was the total amount of dividends per share paid by the company in the last year? ●

Dividend: 1.48

5. Select to look at the 6-month stock graph. On November 21 after trading hours Nordstrom announced its earnings for the third quarter. See https://www.cnbc.com/2019/11/21/nordstrom-jwn-earnings-q3-2019.html. Did the stock price increase or decrease on that day and the following day? Was the trading volume as usual on those two days? Why do you think this was the case? ●

The stock price decreased

6. Nordstrom’s stock has declined quite a bit in the last month. Calculate what would be the approximate capital gains rate had you bought the stock a month ago and sold the stock today (March 25, 2020). Why do you think this decline in price has happened? You may want to look at the following article for clues: https://www.cnbc.com/2020/03/23/nordstrom-suspends-dividend-taps-credit-in-midst-ofcoronavirus.html.

●

Capital gains rate if sold today would decrease. When the price of stock declines, the growth rate also decreases.

Problem 2: Constant Growth Dividend Discount Model Suppose Nordstrom has just paid an annual dividend of $1.48 per share. If you expect the dividend to grow at 6% into indefinite future and if the cost of equity capital is estimated at 11%, what is your estimate of the stock price per share? How does that estimate change if the growth rate expectation changes to 5%? D0 = $1.48 (do not know D1) Growth = 6% Required Return on Equity (RE) = 11% P0 = D1 / RE - g

= D0(1+g) / RE - g = 1.48(1 + .06) / .11 - .06 = $31.38

→ change in g to 5% When growth rate decreases, the stock prices will be lower P0 = D1 / RE - g = 1.48 (1 +.05) / .11 - .05 = $25.90

Problem 3: Changing Growth Dividend Discount Models Because of the change in earnings expectations due to coronavirus epidemic, Nordstrom is expected to suspend paying dividends for the next two years. You expect the dividends to resume starting in year three but growing at the slower rate from that point on. If the dividend in year three is expected at this year’s level of $1.48 per share and if that dividend continues to grow at 4% per year until foreseeable future, what is the estimate of Nordstrom’s stock price today? Assume Nordstrom maintains required return on equity of 11%. When Common stock = no, they do not have to pay dividends No dividends in years 1 and 2, start paying dividends from year 3 and onward D3 = $1.48 G = 4% RE = 11%

Step 1: Find PV value of D3 P0 = D1 / RE -g ⇒ P2 = D3/ RE - g (since we only know D3, much change P0 to P2)

= 1.48/(.11- .04)= 21.14 (P2) P0= P2/(1+RE)^2 =21.14/(1.11)^2 = 17.16

Pr. 4 Sustainable Growth from Reinvestment Laurel Enterprises expects earnings next year of $4 per share and has a 40% retention rate, which it plans to keep constant. Its equity cost of capital is 10%, which is also its expected return on new investment. EPS1(earnings per share) = $4 Retention rate = 40% Dividend payout = 60% (100-40) RE = 10% Return on New Investment (RONI) = 10% (made by the company from the retained earnings) a.

What is the estimate of sustainable growth rate for Laurel? Growth rate = RONI (retention rate) = 10% (40%) = 0.04 → 4 %

b. If its next dividend is due in one year, what do you estimate the firm’s current stock price to be? D1 = EPS1 (dividend payout) = 4 (60%) = $2.40 P0 = D1/ RE - g = 2.40/ .10 - .4 = $40 stock price Stock price = $50 and your estimate is $40 → would this be a good investment? No

c. If the retention rate for Laurel changes to 60%, what effect would it have on the stock price? Did it decrease, increase or not change? Why? Retention Rate = 60% Dividend payout: 40% (1-.6) Growth Rate= (retention rate)(RONI) =(.6)(.1) = 6% Growth is higher, dividend is smaller D1 = EPS1(payout) = 4(.4)= 16 P0 = D1/ RE-G =1.6/ (.1-.06) = $40

Pr. 5 Total Payout Model Suppose Compco Systems pays no dividends but spent $5 billion on share repurchases last year. If Compco’s equity cost of capital is 12%, and if the amount spent on repurchases is expected to grow by 8% per year, estimate Compco’s market capitalization. If Compco has 6 billion shares outstanding, to what stock price does this correspond?...