Question

1. (5) The dividend payment history of the stock of the Princeton Texture since 2011 is as the following: Year Dividend Payment 2011 $1.40 2012 1.45 2013 1.50 2014 1.80 2015 2.10 2016 2.20 2017 2.40 2018 2.50 2019 2.55 2020 2.70 Using Excel compute historical average growth rates using arithmetic and geometric averages. In 2020, the dividend paid by the Princeton Texture was $2.70. Using r = 10% and the growth rate calculated using the arithmetic average above, what is the estimated value of the Princeton Texture's stock assuming that the dividends will grow forever at a constant growth rate? Suppose the market price of the Princeton Texture's stock is $150. Discuss whether the stock is over- or under-valued and the implications for buying/selling decisions.

Answer 1

Calibri 11 -R A ab Wrap Text General BI U Α. Merge & Center % , €0.00 .00 7.0 ainter Font Alignment Number X fr B С D E F G Dividend growth rate Dividend payment year ($) 2011 1.40 2012 1.45 2013 1.50 2014 1.80 2015 2.10 2016 2.20 2017 2.40 2018 2.50 2019 2.55 2020 2.70 Average growth rate (Arithmetic) = Average growth rate (Geometric) = 3.57% 3.45% 20.00% 16.67% 4.76% 9.09% 4.17% 2.00% 5.88% 7.73% 7.57%

As per the constant growth rate model,

Value of stock = Dividend next year/(R - 7.73%)

Value of stock = 2.7*(1+7.73%)/(10% - 7.73%)

Value of stock = $128.14

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Since the market price is $150 and estimated value of stock is $128.14, then it can be said that market price is over priced and stock is overpriced in nature.

It is a right time to sell the stock and get the benefits, because in coming time, its price will come down to realize the estimated value as calculated above. So, it makes people to take decision and sell the stock.