Marge Inovera is trying to value the stock of Hot Tub Time Machines, Limited (HTTM). To easily see how a change in one or more of her assumptions affects the estimated value of the stock, she is using a spreadsheet model. The model has projections for the next four years based on the following assumptions? Sales will be $250 million in year 1.? Sales will grow at 10 percent in years 2 and 3 and at 5 percent in year 4. ? Operating profits (EBIT) will be 20 percent of sales in each year. ? Interest expense will be $ 5 million per year. ? Income tax rate is 30 percent. ? Earnings retention ratio would stay at 0.75. ? The per - share dividend growth rate will be constant from year 4 forward and this final growth rate will be 200 basis points less than the growth rate from year 3 to year 4.
The company has 1 million shares outstanding. Marge has estimated the required return on HTTM’s stock to be 15 percent.
A. Estimate the value of the stock at the end of year 4 based on the preceding assumptions.
B. Estimate the current value of the stock using the same assumptions.
C. Marge is wondering how a change in the projected sales growth rate would affect the estimated value. Estimate the current value of the stock if the sales growth rate in year 3 is 5 percent instead of 10 percent.