Following table shows the dividend scheduled by Honda for year 2009-2012. Assume
ID: 2784146 • Letter: F
Question
Following table shows the dividend scheduled by Honda for year 2009-2012. Assume the dividend growth rate will be steady beyond 2012. Value Line forecasts the retention ratio b = 70% and ROE of 11.0%. The stock price for Honda at the end of year 2008 is $21.37.
Year
Dividend
2009
0.90
2010
0.98
2011
1.06
2012
1.15
a) What should be the long term growth rate for Honda?
b) Assume bHonda = 1.05, risk free rate in 2008 is 3.5%, and Market risk premium is 8%, what is the required rate of return for Honda?
c) Find the intrinsic value for Honda at 2008
d) How do we interpret the intrinsic value we estimated, what if real bHonda = 1.10?
Year
Dividend
2009
0.90
2010
0.98
2011
1.06
2012
1.15
Explanation / Answer
a) Long term growth rate for Honda can be found out from the forecasts of Value line. g = ROE*retention ratio = 11*0.7 = 7.7% b) Required return for Honda as per CAPM = risk free rate+beta*market risk premium = 3.5+1.05*8 = 11.9% c) Intrinsic value for Honda is the PV of its expected dividends discounted at 11.9% PV of dividends for 2009 to 2012 = 0.9/1.119+0.98/1.119^2+1.06/1.119^3+1.15/1.119^4 = $ 3.08 Terminal value of the dividends at t4 (EOY 2012) growing at a constant rate to perpetuity = 1.15*1.077/(0.119-0.077) = $ 29.49 PV of the terminal value of dividend = 29.49/1.119^4 = $ 18.81 Intrinsic value of the share at EOY 2008 = 3.08+18.81 = $ 21.88 d) The intrinsic value estimated under [c] is above the 2008 stock price of $21.37. We may say that the stock is undervalued by the market. If the beta is 1.10, the required return will be = 3.5+1.1*8 = 12.3% The intrinsic value will be as below: PV of dividends for 2009 to 2012 = 0.9/1.123+0.98/1.123^2+1.06/1.123^3+1.15/1.123^4 = $ 3.05 Terminal value of the dividends at t4 (EOY 2012) growing at a constant rate to perpetuity = 1.15*1.077/(0.123-0.077) = $ 26.93 PV of the terminal value of dividend = 26.93/1.123^4 = $ 16.93 Intrinsic value of the share at EOY 2008 = 3.05+16.93 = $ 19.98 The intrinsic value will be less than the stock price and the stock will be considered as overvalued by the market.