Assignment 2

Stock Valuation
 This assignment is ONLY for those who choose to
continue the course and get a letter grade

 This assignment is out of 15 marks

 Deadline for submission: Tuesday 9th of June (9/6/2020)

 Late submissions will not be accepted and will therefore be

graded Zero

 This assignment should be done individually, and therefore

identical work will be graded Zero

 Oral Assessment is MANDATORY, out of 10 marks, and

will take place via Zoom on Wednesday 10th of June

 You can submit this assignment in your own hand-writing

as an image (this applies ONLY to assignment 2)
THE SWISS WEALTH CORP.

The Swiss Wealth Corp. (SWC) is in the final stage of its growth phase. While the
variability in the company's earnings has decreased significantly, its revenue
growth rates, though still impressive, are beginning to slow down. As the company
is turning into a “cash cow”, the question arises what to do with the free cash flow
it generates. Since an increasing portion of this cash cannot be reinvested at rates
higher than the company's cost of capital, a necessary condition to increase firm
value, the management has decided to pay an annual dividend for the first time in
the company's history, starting next year with CHF1.60.

Having noticed the dividend announcement in the local business newspaper, you
wonder if buying shares in SWC would be a lucrative idea. After all, you are a
total return investor, that is, you favor a mix of capital gains and dividend income.

From your investment experience, you know that it often takes a few years
before a newly dividend-paying company establishes a somewhat constant
dividend policy. Based on your analysis of the dividend paying behavior of
companies that in the past were in a financial position similar to that of SWC, you
estimate the next dividends to be CHF2.10, CHF2.50, and CHF2.85 for years 2, 3,
and 4, respectively. For the years to follow, you anticipate an annual dividend
growth rate that reflects the industry average of 4 percent. Upon the dividend
announcement, SWC shares went up by almost 1.25 percent and are currently
trading at CHF46.85. You have calculated the market's required return for SWC's
industry rivals to be 8.75% on average.


 Required

1. Applying the Dividend Discount Model (DDM), determine SWC's intrinsic

value per share. Should you buy the shares?
Present Value = Price of the stock = P4 = D5/K-G

 D5 = D4(1+G)= 2.85 (1+4%)= 3.08

 P4 = 3.08(8.75%-4%) =64.896
 Price=1.60(1+8.75%)
+2.10(1+8.75%)^2+2.50(1+8.75%)^3+2.85(1+8.75%)^4+64.896(1+8.75%)^4= 53.62
 The current MV is 46.85 The stock is under priced We should buy it

2. Four years later (in year 4), the company has implemented a constant growth
dividend policy of 4% based on earnings per share of CHF13.5 and a dividend
payout ratio of 0.2. SWC has just paid a dividend of CHF2.70 (instead of 2.85
as you had originally projected).

a. Compute the share price in year 4 using the constant growth dividend
model.
 D4 =2.70
 D5= D0(1+G)= 2.70(1+4%)= 2.808
 P4= 2.808/8.75%-4%= 59.11
b. Assume you buy the shares at the price computed in 2a., and sell them
one year later, compute the share price in year 5 using the constant
growth dividend model. If you receive the dividend at the end of your
investment period (the dividend of year 5), how much is your net
profit/loss after selling the stock?
 D6= D5(1+G)= 2.808 (1+4%)=2.92
 P5 = D6/K-G= 2.92/8.75%-4%=61.4
 Profit = 61.4 -59.11+2.808=5.17 /Share

c. Many companies increase the dividend payout ratio (DPO) once they
have entered the maturity phase. What effect does this have on the
share prices you computed and consequently on your decision
regarding investing in this stock?
 Higher expected dividends would have increased the present value we computed for the
stock ,but again the decision is based on the current price and whether the stock is under
pr over priced and we have to take into consideration that one important factor that a
higher dividend can be reinvested and generate additional profits
 In other point of view higher payout means less retained earnings and accordingly less
growth opportunities and less capital gains in the future