Question

Wilbur and Orville are brothers.​ They're both serious​ investors, but they have different approaches to valuing stocks.​ Wilbur, the older​ brother, likes to use the dividend valuation model. Orville prefers the free cash flow to equity valuation model. As it turns​ out, right​ now, both of them are looking at the same stock - Wright First​ Aerodynmaics, Inc.​ (WFA). The company has been listed on the NYSE for over 50 years and is widely regarded as a​ mature, rock-solid,​ dividend-paying stock. The brothers have gathered the following information about​ WFA's stock:

Current dividend ​(Upper D 0​) = $3.30​/share

Current free cash flow ​(FCF 0​) = $1.5 million

Expected growth rate of dividends and cash flows ​(g​)= 7​%

Required rate of return ​(r​)equals 15​% Shares outstanding = 350,000 shares

How would Wilbur and Orville each value this​ stock?

Answer 1

Wilbur

Value of stock = current dividend * (1 + growth rate) / (required return - growth rate)

Value of stock = $3.30 * (1 + 7%) / (15% - 7%)

Value of stock = $44.14

Orville

Value of equity = current FCF * (1 + growth rate) / (required return - growth rate)

Value of stock = value of equity / Shares outstanding

Value of equity = $1,500,000 * (1 + 7%) / (15% - 7%) = $20,062,500

Value of stock = value of equity / Shares outstanding

Value of stock = $20,062,500 / 350,000 = $57.32