10. Janet Ludlow’s firm requires all its analysts to use a two-stage dividend discount model (DDM)

and the capital asset pricing model (CAPM) to value stocks. Using the CAPM and DDM, Ludlow has valued QuickBrush Company at $63 per share. She now must value SmileWhite Corporation.

a. Calculate the required rate of return for SmileWhite by using the information in the following table:

QuickBrush SmileWhite Beta 1.35 1.15 Market price $45.00 $30.00 Intrinsic value $63.00 ?

Notes:

Risk-free rate 4.50%

Expected market return 14.50%

b. Ludlow estimates the following EPS and dividend growth rates for SmileWhite:

First 3 years 12% per year Years thereafter 9% per year Estimate the intrinsic value of SmileWhite by using the table above, and the two-stage DDM.
Dividends per share in the most recent year were $1.72.

c. Recommend QuickBrush or SmileWhite stock for purchase by comparing each company’s intrinsic value with its current market price.

d. Describe one strength of the two-stage DDM in comparison with the constant-growth DDM.
Describe one weakness inherent in all DDMs.