Problem
Veldskoen (Pty) Ltd has been listed on the JSE for many years and is a well-established manufacturing business in South Africa. They are in the business of manufacturing shoes. The company is evaluating a variety of different aspects of their business and have hired you as a consultant to assist them with the questions below:
The first question that management have asked you to help them with is what their company would be valued at per share in the eyes of any potential buyer (besides the listed share price). You have established that the company intends paying a dividend of R4 per share shortly and that they have grown dividends in the past and expect to do so in the future at a constant 6%. Risk-free rate is 8.5% and the expected return on the market portfolio is 18.5%. Veldskoen's stock has a beta of 0.75.
A. Using the Dividend Growth Model, determine the value of a share in Veldskoen (Pty) Ltd.
B. If the share of Veldskoen (Pty) Ltd is trading on the market at R20 and based on your answer in a) above, will a potential buyer believe the share is trading at a discount or at a premium to its true value?
C. If dividend growth forecast for Veldskoen are revised upward to 7% per year,
a. What will happen to the price of Veldskoen stock?
b. What (qualitatively) will happen to the Veldskoen price-earnings ratio?
D. At Veldskoen, a director of the company said that the use of dividend discount models by investors is "proof" that the higher the dividend, the higher the stock price. Using a constant-growth dividend discount model as a basis of reference, evaluate the director's statement.
E. A competing consultant claims that Veldskoen is in startup phase of industry life cycles. Given the information above do you agree with the consultant? (yes or no) Give reasons why.
F. Is Veldskoen likely to be a defensive or cyclical business in terms of business cycle sensitivity? Briefly explain why?