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Tutorial 3

This document contains a tutorial on equity valuation from Tunis Business School. It includes multiple choice questions covering topics like undervalued/overvalued securities, appropriate analyst actions, and the dividend growth model. It also includes exercises calculating earnings per share, dividend per share, stock value under different growth assumptions, and analyzing a company's total return, dividend yield, and capital gains yield during periods of normal and supernormal growth.

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28 views

Tutorial 3

This document contains a tutorial on equity valuation from Tunis Business School. It includes multiple choice questions covering topics like undervalued/overvalued securities, appropriate analyst actions, and the dividend growth model. It also includes exercises calculating earnings per share, dividend per share, stock value under different growth assumptions, and analyzing a company's total return, dividend yield, and capital gains yield during periods of normal and supernormal growth.

Uploaded by

casatn099
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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University of Tunis

Tunis Business School


Principles of Finance
Tutorial n°3: Equity Valuation
Professor: Dr. Ridha ESGHAIER
(Spring 2023)

Multiple Choice Questions:

Q1. An analyst finds that all the securities analyzed have estimated values higher than their market prices.
The securities all appear to be:
a. overvalued.
b. undervalued.
c. fairly valued.

Q2. An analyst finds that nearly all companies in a market segment have common shares which are
trading at market prices above the analyst’s estimate of the shares’ values. This market segment is widely
followed by analysts. Which of the following statements describes the analyst’s most appropriate first
action?
a. Issue a sell recommendation for each share issue.
b. Issue a buy recommendation for each share issue.
c. Reexamine the models and inputs used for the valuations.

Q3. An analyst, using a number of models and a range of inputs, estimates a security’s value to be
between ¥250 and ¥270. The security is trading at ¥265. The security appears to be:
a. overvalued.
b. undervalued.
c. fairly valued.
Q4. Company A currently pays an annual dividend of $1.35 and plans on increasing that amount by
2.5 percent each year. Company B currently pays an annual dividend of $1.20 and plans on increasing
its dividend by 3 percent annually. Given this information, you know for certain that the stock B has a
higher ______ than the stock A.
a. market price
b. dividend yield
c. capital gains yield
d. total return
e. The answer cannot be determined based on the information provided
Q5. An increase in which of the following will increase the current value of a stock according
to the dividend growth model?
a. dividend amount.
b. number of future dividends, provided the current number is less than infinite.
c. discount rate
d. dividend growth rate.
e. none of the above

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Q6. Which of the following statements is correct?
a. The capital gains yield is the annual rate of change in a stock's price.
b. Preferred stocks have constant growth dividends.
c. A constant dividend stock cannot be valued using the dividend growth model.
d. The dividend growth model can be used to compute the current value of any stock.
e. An increase in the required return will decrease the capital gains yield.
Q7. A company has a dividend-paying stock with a total return for the year of -6.5%.
Which one of the following must be true?
a. The dividend must be constant.
b. The dividend yield must be negative.
c. The stock has a negative capital gains yield.
d. The required rate of return for this stock increased over the year.
e. The firm is experiencing supernormal growth

EXERCISES:
Exercise 1: Non-constant growth valuation
A company currently pays a dividend of $2 per share (D0 = $2). It is estimated that the company’s dividend will
grow at a rate of 20% per year for the next 2 years, then at a constant rate of 7% thereafter. The required return
on the company’s stocks is 12.3%.
What is your estimate of the stock’s value at t=0?

Exercise 2: EPS, DPS and stock Value


Consider the following expected situation regarding the company « ABC » at the beginning of 2021:

Projected income statements


2021 2022 2023 2024 2025 2026
Sales 2,000,000 2,300,000 2,700,000 2,900,000 2,950,000 3,000,000
Op. Cost exc. Dep & Amt 820,000 880,000 970,000 1,120,000 1,130,000 1,135,000
Dep. & Amt 250,000 260,000 282,000 300,000 305,000 310,000
Interest Expense 123,000 128,000 180,000 170,000 170,000 170,000

Tax rate: 33.33%


The Dividend payout ratio: 70%
The common stock amount is $4,200,000 and the nominal (par) value is $50.
The required rate of return on the company’s stocks is: 15%
Calculate :
1- The expected EPS for each year
2- The expected DPS for each year
3- The « ABC » stock value at the beginning of 2021 (after the payment of DPS2020) in each of the following cases:
A) g : constant growth rate after DPS2026 = 0 %
B) g : constant growth rate after DPS2026 = 5 %
C) g : constant growth rate after DPS2026 = -1.5%
Exercise 3: Non-constant growth valuation
Consider the company “ XYZ ” and assume that:
The required rate of return on the company’s stock is 14.5%. The last dividend paid D0= $4.5. The upcoming five
years will be a non-constant growth period for the company during which it will distribute the following dividends:
D1 = $4.8; D2 = $4.6; D3 = $4.6; D4 = $5 and D5 = $5.1.
Calculate the stock value in each of the following cases:
1) g : constant growth rate after the non-constant growth period = the average growth rate over the non-constant
growth period
2) g : constant growth rate after the non-constant growth period = 7%
3) g : constant growth rate after the non-constant growth period = 0 %
4) g : constant negative growth rate after the non-constant growth = -3%

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Exercise 4: Supernormal Growth, and evolution of yields
A Company is experiencing a period of rapid growth. Earnings and dividends are expected to grow at a
rate of 15% during the next 2 years, at 13% in the third year, and at a constant rate of 6% thereafter. The
company’s last dividend was $1.15, and the required rate of return on the stock is 13%.
a. Calculate D1, D2, D3, D4 and D5
b. Calculate the value of the stock today ( P̂0 ).

c. Calculate P̂1 , P̂2 and P̂4


d. Calculate the dividend yield and capital gains yield for Years 1, 2, 3 and 4.
What is your conclusion about the evolution of the company’s total return, dividend yield and capital gains
yield during its period of supernormal growth and once this period of supernormal growth ends?

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