Question

Barbara Bailey, has always been fascinated by the world of clothing. She left her previous job as vice-president of marketing and design to launch her own clothing firm. During the year of 20X9, her international company, Bailey Clothiers, grew to $ 200 million in sales after 10 years in business. Her fashion line covered all of the latest trends and designs from hats, sweaters, suits, sweatshirts, pants, socks and shoes. Her stores are located in business districts around the country and they have a strong social media presence.

Bailey Clothiers is doing very well. The company has grew very rapidly over the past few years that securities analysts were surprised by such growth. However, securities analysts are concerned that the company may not be able to keep up such a pace. They are concerned that competition is becoming more intense and that market saturation is a very real possibility. They estimated that stockholders also should expect much slower growth to no growth and they should not expect to receive any dividends in the future.

Barbara Bailey does not believe in analyst predictions. She feels that the company could maintain a constant annual growth rate in dividends per share of 6% in the future or possibly 8% for the next two years and 6% thereafter. Bailey is basing her estimates on an established long-term investment plan into the Latin American, European and Canadian Markets. By venturing into these markets the risk of the firm will increase. The company estimates that the risk premium will increase from 8.9% to 10%. Currently, the company has a risk premium of 6%.

In preparing the long-term financial plan, Bailey Clothiers' chief financial officer has assigned financial analyst, Scott Markham, to evaluate the firm's current stock price. He has asked Scott to consider the conservative predictions of the securities analysts and the aggressive predictions of Barbara Bailey.

Scott has compiled the following information from the 20X9 data to assist in his analysis:

Data: 20X9 Value

Earnings per share (E.P.S.) $ 5.25

Price per share of common stock 42.00

Book value of common stock equity $ 48,000,000

Total common shares outstanding 3,000,000

Common stock dividend per share $ 3.50

Required:

Please answer the following questions:

1. What is the company's current book value per share? $16 per share
2. What is the firm's current P/E Ratio? Firm’s P/E ratio is 12.5%
3. What is the current required return for Bailey Clothiers' stock? The current required return is 6%.
4. What will be the new required return for Bailey Clothiers' stock assuming that they expand into the Latin American, European and Canadian markets as planned? The required rate of return for the company after the expansion will be 16.34%
5. Assuming that the securities analysts are correct in predicting that there is no growth in future dividends, what will be the value per share on Bailey Clothiers' stock? (Note: Please use the new required return on the company's stock here.)
6. If Barbara Bailey's predictions are correct, what will be the value per share of Bailey Clothiers' stock if the firm maintains a constant annual 6% growth rate in future dividends? (Note: Please use the new required return to answer this question.
7. If Barbara Bailey's predictions are correct, what will be the value per share of Bailey Clothiers' stock if the firm maintains a constant annual growth rate in dividends per share over the next 2 years and 6% thereafter?
8. Compare the current (20X9) price of the stock and stock values found in parts A, E, F and G. Please discuss in (one paragraph) why there are differences in the values. Which valuation method do you believe most clearly represents the true value of Bailey Clothiers' stock?

I got the first few, but am stuck on the bottom ones. Please double check if the top ones are correct too. Thank you!

Answer 1

Answer 2

A. The company's current book value per share is calculated by dividing the book value of common stock equity by the total common shares outstanding:

Book value per share = Book value of common stock equity / Total common shares outstanding = $48,000,000 / 3,000,000 = $16 per share.

B. The current P/E ratio is calculated by dividing the price per share of common stock by the earnings per share:

P/E ratio = Price per share / Earnings per share = $42.00 / $5.25 = 12.5.

C. The current required return for Bailey Clothiers' stock is given as 6%.

D. The new required return for Bailey Clothiers' stock after the expansion is estimated to be 10% (current risk premium of 6% plus an additional 4% for the increased risk of the expansion).

E. If there is no growth in future dividends, the value per share of Bailey Clothiers' stock can be calculated using the constant dividend discount model:

Value per share = Dividend per share / (Required return - Growth rate) = $3.50 / (0.1634) = $21.43.

F. If the firm maintains a constant annual growth rate of 6% in future dividends, the value per share of Bailey Clothiers' stock can be calculated using the constant dividend growth model:

Value per share = Dividend per share × (1 + Growth rate) / (Required return - Growth rate) = $3.50 × (1 + 0.06) / (0.1634 - 0.06) = $51.03.

G. If the firm maintains a constant annual growth rate of 8% for the next two years and 6% thereafter, the value per share of Bailey Clothiers' stock can be calculated using the two-stage dividend growth model:

Value per share = (Dividend per share × (1 + Growth rate 1) / (Required return - Growth rate 1)) + ((Dividend per share × (1 + Growth rate 2) / (Required return - Growth rate 2)) / (1 + Required return - Growth rate 1)) = ($3.50 × (1 + 0.08) / (0.1634 - 0.08)) + (($3.50 × (1 + 0.06) / (0.1634 - 0.06)) / (1 + 0.1634 - 0.08)) = $56.36.

H. There are differences in the values calculated using the different valuation methods because they each make different assumptions about the growth rate of the company's dividends. The constant dividend discount model assumes no growth in future dividends, while the constant dividend growth model assumes a constant growth rate in future dividends. The two-stage dividend growth model assumes a higher growth rate for the next two years and a lower growth rate thereafter. Additionally, the models use different required rates of return, which are based on different assumptions about the company's risk.

Among the different valuation methods, the two-stage dividend growth model may provide a more accurate estimate of the true value of Bailey Clothiers' stock because it takes into account the company's changing growth rate over time. However, it is important to note that all valuation methods have limitations and uncertainties, and investors should use multiple methods to arrive at a more informed decision.