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Analyst Debra Williams must decide whether to invest in one of two stocks (A and B). Both A and B are trading at $100 per share.
Her forecasts for company A as of the beginning of 2016 are the following:
Assume: Terminal growth in perpetuity 3.5%; cost of capital 9%; 10 million shares outstanding.
Forecast ($ millions)
2016
2017
Terminal Value
Net Income
100
108
113
Dividend
10
11
13
Beginning Book Value of Equity
900
Residual NI
Discount Factors:
1
2
3
Present Value of $1 at 9%
0.917
0.842
0.772
(a) Based on the assumptions above, what is the intrinsic value of A's stock at the beginning of 2016?
Williams estimates that company B has reached its steady state. Beginning book value of equity is 100 per share; current ROE is 9%; cost of capital 9%; and perpetual growth expected to be 3.5%.
(b) Based on the assumptions above, what is the intrinsic value of B's stock?
(c) Which stock should Williams buy? Why?
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