(Adapted from 1998 CFA Level I1 exam) Janet Ludlow”s company requires all its analysts to use a two-stage DDM and the CAPM to value stocks. Using these models, Ludlow has valued Quick Brush Company at $63 per share. She now must value Smile White Corporation.
| EXHIBIT 21-1 Valuation Information: December 1997 Don't use plagiarized sources. Get Your Custom Essay on estimate the intrinsic value of smilewhite using the data above and the two stage dd 543651 For $10/Page 0nly | ||
| Quick Brush | Smile White | |
| Beta | 1.35 | 1.15 |
| Market price | $45.00 | $30.00 |
| Intrinsic value | $63.00 | ? |
| Notes: | ||
| Risk-free rate | 4.50% | |
| Expected market return | 14.50% | |
A. Calculate the required rate of return for SmileWhite using the information in Exhibit 21-1 and the CAPM. Show your work.
Ludlow estimates the following EPS and dividend growth rates for Smile White:
| First three years: | 12% per year |
| Years thereafter: | 9% per year |
The 1997 dividend per share is $1.72.
B. Estimate the intrinsic value of SmileWhite using the data above and the two-stage DDM. Show your work.
C. Recommend Quick Brush or Smile White stock for purchase by comparing each company”s intrinsic value with its current market price. Show your work.
D. Describe one strength of the two-stage DDM in comparison with the constant growth DDM. Describe one weakness inherent in all DDMs.
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