Assume? you've generated the following information about thestock of? Bufford's Burger? Barns: The? company's latest dividendsof ?$3.51 a share are expected to grow to ?$3.90 next? year, to?$4.33 the year after? that, and to ?$4.81 in year 3. After? that,you think dividends will grow at a constant 6 ?% rate.
a. Use the variable growth version of the dividend valuation modeland a required return of 15 ?% to find the value of thestock.
b. Suppose you plan to hold the stock for three? years, selling itimmediately after receiving the ?$4.81 dividend. What is the?stock's expected selling price at that? time? As in part a?, assumea required return of 15 ?%.
c. Imagine that you buy the stock today paying a price equal to thevalue that you calculated in part a. You hold the stock for three?years, receiving dividends as described above. Immediately afterreceiving the third? dividend, you sell the stock at the pricecalculated in part b. Use the IRR approach to calculate theexpected return on the stock over three years. Could you haveguessed what the answer would be before doing the?calculation?
d. Suppose the? stock's current market price is actually ?$45.83 .Based on your analysis from part a?, is the stock overvalued or?undervalued?
e. A friend of yours agrees with your projections of? Bufford'sfuture? dividends, but he believes that in three? years, just afterthe company pays the ?$4.81 ?dividend, the stock will be selling inthe market for ?$56.79 . Given that? belief, along with the?stock's current market price from part d?, calculate the returnthat your friend expects to earn on the stock over the next threeyears.
