Larry, Moe and Curly are brothers. They're all serious investors, but each has a different approach to valuing stocks. Larry likes to use a 1 year holding period to value common shares. Moe likes to use multiyear holding periods. Curly prefers the dividend valuation model. As it turns out, all three of them are looking at the same stock. American Home Care products, Inc (AHCP). The company has been listed on the NYSE for over 50 years and is widely regarded as a mature, rock-solid, divided paying stock. The brothers have gathered the following information about AHCP's stock;
Current dividend (D0) = $2.50/share
Expected Growth rate (g) =9.0%
Required Rate of Return (k) =12.0%
All 3 of them agree that these variables are appropriate, and they will use them in valuing the stock. Larry and Moe intend to use the D&E approach; Curly is going to use the constant-growth DVM. Larry will use a 1 year holding period; he estimates that with a 9% growth rate, the price of the stock will increase to $98.80 by the end of the year. Moe will use a 3 year holding period; with the same 9% growth rate, he projects the future price of the stock will be $117.40 by the end of his investment horizon. Curly will use the constant-growth DVM, so his holding period isn't needed.
a) Use the information provided above to value the stocks first for Larry, then for Moe, then for Curly.
b) Comment on your findings. Which approach seems to make the most sense?
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Below are my answers.
Anna Liza Gaspar
Larry: P0 = [D0 x(1+g) ]/(1+k) + P1/(1+k) = [2.5*(1.09)]/(1.12) + 98.80/1.12 = $90.65
Moe: P0 = D1/(1+k) ...
This solution answers questions pertaining to dividend valuation and stock value.