Mini case from the book - Introduction to Corporate Finance 3rd Ed. pg 179 - Valuing stocks
Case - your investment adviser has sent you three analyst reports for a young, growing company named Vegas Chips Inc.. These reports depict the company as spectulative, but each one poses different projections of the company's future growth rate in earning and dividends. all three reports show that vegas chips earned $1.20 per share in the year just ended. There is consensus that a fair rate of return to investors for this common stock is 14% and that management expects to consistently earn a 15% return on the book value of equity (ROE = 15%).
I am required to answer #4 question.
Discuss the features(s) that drive the differing valuations of vegas chips. what additional information do you need to garner confidence in the projections of each analyst report?
There are 3 questions prior to this question that may be pertinent to the solution of this. Will you need this information to answer this question?
1. The analyst who produced report A makes the assumption that vegas chips will remain an small, regional company that, although profitable, is not expected to grow. in this case, vegas chips management is expected to elect to pay out 100% of earnings as dividends. based on this report, what model can you use to value a share of common stock in vegas chips? using this model what is the value
2. the analyst who produced report B makes the assumption that vegas chips will enter the national market and grow at a steady constant rate. in this case, vegas chips management is expected to elect to pay out 40% of earnings as dividends. this analyst discloses news that this dividend has just been committed to current stockholders. Based on this report, what model can you use to value a share of common stock in vegas chips? Using this model what is the value
3. the analyst wo produced report C also makes the assumption that vegas chips will enter the national market but expects a high level of initial excitement for the product that is then followed by growth at a constant rate. earnings and dividends are expected to grow at a rate of 50% over the next year, 20% for the following two years, and then revert back to a constant growth rate of 9% thereafter. this analyst also discloses that vegas chips management has just announced the pay out of 40% of the recently reported earnings to current stockholders. based on this report, what model can you use to value a share of common stock in vegas chips? using this model what is the value?