Allie Reynolds, the Chief Financial Officer of Healthy Products, Inc., has been asked The Capital Budgeting Process Compute the price of the stock at the end of the fourth year (P4).

dell);

del ees:

(D; is equal to D, times 1.06)

P, After you have computed P,, discount it back to the present at a discount rate of 13 percent for four years.

Add together the answers in part b and part d to get Po, the current value of the stock. This answer represents the present value of the four periods of dividends, plus the present value of the price of the stock after four periods,

(which, in turn, represents the value of all future dividends).

Use Formula 10-9 to show that it will provide approximately the same answer as part e.

Py = —=D— ,

: Kee 2 For Formula 10-9 use D, = $4.24, K, = 13 percent, and g = 6 percent.

(The slight difference between the answers to part e and part fis due to rounding.)

If current EPS were equal to $5.70 and the P/E ratio is 1.2 times higher than the industry average of 9, what would the stock price be?

By what dollar amount is the stock price in part g different from the stock price in part f?

In regard to the stock price in part

f, indicate which direction it would move if (1) D, increases, (2) K, increases, (3) g increases.

E to do an evaluation of Fiber Cereals, Inc., by the President and Chairman of the Board, Gail Martinez. Healthy Products was planning a joint venture with Fiber Cereals

(which was privately traded), and Gail and Allie needed a better feel for Fiber Cereals’

common stock value because they thought they might be interested in buying the firm in the future.

Fiber Cereals paid a dividend at the end of year 1 of $1.20; the anticipated growth rate was 10 percent; and the required rate of return was 13 percent.

a. What is the value of the stock based on the dividend valuation model (Formula 10-9 on page 297)?

b. Indicate that the value you computed in part a is correct by showing the value of D,, D3, and D; and discounting each to the present 13 percent. D, is $1.20 and it increases by 10 percent (g) each year. Also discount back the anticipated stock price at the end of year 3 to the present and add it to the present value of the three dividend payments.

The value of the stock at the end of year 3 is:
Dy 1S reg D,= D 3 (1 + g)
If you have done all these steps correctly, you should get an answer approximately equal to the answer in part a.

c. As an alternative measure, you also examine the value of the firm based on the price-earnings (P/E) ratio times earnings per share.
Since the company is privately traded (not in the public stock market), you will get your anticipated P/E ratio by taking the average value of five publicly traded food industry companies. These P/E ratios were as follows during the time period under analysis:

Assume Fiber Cereals has earnings per share of $2.45. What is the stock value based on the P/E ratio approach? Multiply the average P/E ratio you computed times earnings per share. How does this value compare to the dividend valuation model values that you computed in parts a and b?

d. If in computing the industry average P/E, you decide to weight Kellogg by 40 percent and the other four firms by 15 percent, what would be the new weighted average industry P/E? (Note: You decided to weight Kellogg more heavily because it is similar to Fiber Cereals.) What will the new stock price be?
Earnings per share will stay at $2.45.

e. By what percent will the stock price change as a result of using the weighted average industry P/E ratio in part d as opposed to that in part c?

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Del Monte.... General Mills.. Heinz. Kellogg. Kraft P/E Ratio 12 15 14 22 17