Question

Urban Drapers Inc., a drapery company, has been successfully doing business for the past 15 years. It went public eight years ago and has been paying out a constant dividend of $2.24 per share every year to its shareholders. In its most recent annual report, the company informed investors that it expects to maintain its constant dividend into the foreseeable future and that dividends are not expected to increase.

If you are an investor who requires a 25.50% rate of return and you expect dividends to remain constant forever, then your expected valuation for Urban Drapers stock today is ________ per share. Urban Drapers has a sister company named Super Carpeting Inc. (SCI). SCI just paid a dividend (D_0) of $2.64 per share, and its annual dividend is expected to grow at a constant rate (g) of 5.50% per year. If the required return (r_s) on SCI's stock is 13.75%, then the intrinsic value of SCI's shares is _______ per share.

Answer 1

a. The expected valuation for Urban Drapers stock today is $8.78 per share

b. The intrinsic value of SCI's shares is $33.76 per share.

Step-by-step explanation:

a. Calculation of the expected valuation for Urban Drapers

Expected valuation for Urban Drapers stock today = Constant annual dividend per share / Required rate of return = $2.24 / 25.50% = $8.78

Theerefore, the expected valuation for Urban Drapers stock today is $8.78 per share.

b. Calculation of the intrinsic value of SCI's shares

This can be calculated using the using the Gordon growth model (GGM) formula as follows:

P = D_1 / (r - g) ............................ (1)

Where,

P = current stock price = Intrinsic value of SCI's shares = ?

D_1 = Next dividend = D_0 * (100% + g) = $2.64 * (100% + 5.50%) = $2.7852

r = required return = 13.75%, or 0.1375

g = Expected annual dividend growth rate = 5.50%, or 0.0550

Substituting the values into equation (1), we have:

P = $2.7852 / (0.1375 - 0.0550)

P = $33.76

Therefore, the intrinsic value of SCI's shares is $33.76 per share.