1. A decrease in the dividend payout ratio will most likely decrease the intrinsic value when using a(n):
A. multiplier model.
B. asset-based valuation model.
C. present value model.
2. Which of the following is least likely to be an assumption of the Gordon growth model?
A. Dividend growth rate, g, must be constant throughout.
B. Required rate of return is always greater than dividend growth rate.
C. Required rate of return, r may be expected to change.
3. Arcal Co.’s stock is selling at $34 and has a P/E multiple of 14 on the basis of the current year’s earnings. An analyst estimates that next year’s earnings per share for Arcal Co. will be 5% higher and that the stock should be valued on a forward looking basis at the industry average P/E of 15. Based on the analyst’s assessment, it is most likely that the stock is currently:
A. fairly valued.
1: C is correct. A decrease in the dividend payout ratio will decrease the cash expected to be distributed to shareholders. The Dividend discount model is the present value of the cash expected to be distributed to shareholders. Therefore a decrease in the dividend payout ratio will decrease the intrinsic value in a present value model.
2: C is correct. Required rate of return is assumed to be constant in the Gordon growth model and thus is not expected to change.
3: C is correct. Current year EPS = 34/14 = 2.43. Next year’s EPS = 2.43* 1.05 = 2.55. Intrinsic value = = 38.25. The market price is lower than the intrinsic value and so the stock is undervalued