Hangovers, Inc. is a little known producer of an aspirin substitute; thus, analysts dispute the earnings and dividend growth prospects of the company. Mr. Walker is forecasting 8% growth in dividends indefinitely. However, Mr. Daniels is predicting a 9% growth in dividends, but only for the next 2 years, after which the growth rate is expected to decline to 4% for the indefinite future. Hangovers, Inc. dividend per share is currently $3, and the company has a beta of 1.5. The risk-free rate is 2% and the expected return on the market is 10%.
A. Using the CAPM, determine what the appropriate required rate of return is for this stock (given its level of risk).
B. Using this value, what is the intrinsic value of the stock according to Mr. Walker? What is it according to Mr. Daniels?
C. Assume that the stock now sells for $42 per share. If the stock is fairly priced at the present time, what’s the expected rate of return according to Mr. Walker?
D. Would Mr. Walker consider this stock to be a “Buy” or a “Sell”? What about Mr. Daniels?