Snowflakes Sdn Bhd Expects To Grow At 10% Rate

Snowflakes Sdn Bhd Expects To Grow At Current Rate Of 10 Percent Per A

Snowflakes Sdn Bhd expects to grow at a current rate of 10 percent per annum for the next 2 years and then at 8 percent per annum indefinitely thereafter. Calculate the current share price of Snowflakes Sdn Bhd assuming the rate of return on equity is 12 percent per annum and the last year dividend was RM1.00 per share. Additionally, determine the required return for a firm paying a current dividend of RM1.50, expecting a 5 percent indefinite growth, with a current share value of RM35.00, using the constant-growth dividend discount model.

Paper For Above instruction

The valuation of a company's stock fundamentally hinges upon the projected future dividends and the expected return on investment. In this analysis, we will explore the valuation methods for Snowflakes Sdn Bhd, considering its growth rates, and subsequently evaluate the required rate of return for a different firm using the dividend discount model (DDM).

Valuation of Snowflakes Sdn Bhd

Snowflakes Sdn Bhd is expected to grow at 10% annually for the next two years, then at 8% indefinitely. This mixed growth scenario can be approached through a two-stage dividend discount model (DDM), which combines a short-term growth period with a perpetual growth thereafter.

Starting with the dividend last year (D0) of RM1.00, we first project the dividends for the next two years:

- D1 = D0 (1 + g1) = RM1.00 (1 + 0.10) = RM1.10

- D2 = D1 (1 + g1) = RM1.10 (1 + 0.10) = RM1.21

From year 3 onwards, dividends grow at a perpetual rate of 8%:

- D3 = D2 (1 + g2) = RM1.21 (1 + 0.08) = RM1.3088

The stock price at the end of Year 2, based on the perpetuity starting from Year 3, can be estimated using the Gordon Growth Model:

\[ P_2 = \frac{D_3}{r - g_2} \]

where:

- \( D_3 = RM1.3088 \)

- \( r = 0.12 \) (rate of return)

- \( g_2 = 0.08 \) (perpetual growth rate)

Plugging in the values:

\[ P_2 = \frac{RM1.3088}{0.12 - 0.08} = \frac{RM1.3088}{0.04} = RM32.72 \]

Next, the present value of the expected dividends for the first two years, along with \( P_2 \), are discounted back to today using the required rate of return:

\[ P_0 = \frac{D_1}{(1 + r)^1} + \frac{D_2}{(1 + r)^2} + \frac{P_2}{(1 + r)^2} \]

Calculating each component:

- PV of D1:

\[ \frac{RM1.10}{1.12} \approx RM0.98 \]

- PV of D2:

\[ \frac{RM1.21}{(1.12)^2} \approx RM0.97 \]

- PV of \( P_2 \):

\[ \frac{RM32.72}{(1.12)^2} \approx RM26.07 \]

Adding these components, the current share price:

\[ P_0 \approx RM0.98 + RM0.97 + RM26.07 = RM28.02 \]

Therefore, based on the given assumptions and expected growth patterns, the estimated current share price of Snowflakes Sdn Bhd is approximately RM28.02.

---

Determining the Required Rate of Return Using the Constant-Growth DDM

For the second part, the firm pays a current dividend of RM1.50, with expectations of a 5% indefinite growth rate, and a current share price of RM35.00.

The Constant Growth Dividend Discount Model (Gordon Growth Model) is expressed as:

\[ r = \frac{D_1}{P} + g \]

where:

- \( D_1 = D_0 \times (1 + g) = RM1.50 \times (1 + 0.05) = RM1.575 \)

- \( P = RM35.00 \)

- \( g = 0.05 \)

Putting these into the formula:

\[ r = \frac{RM1.575}{RM35.00} + 0.05 \]

\[ r \approx 0.045 + 0.05 = 0.095 \text{ or } 9.5\% \]

Hence, the required return on this investment is approximately 9.5%.

Conclusion

The valuation process for Snowflakes Sdn Bhd involves projecting dividends based on specified growth rates and discounting these cash flows using the required rate of return. For Snowflakes, the estimated current share price is RM28.02, considering a two-stage growth model. Meanwhile, the second firm demonstrates a required return of 9.5%, based on the constant-growth dividend discount model, given its current dividend, share price, and growth expectations. Both models rely heavily on assumptions about future dividends and growth rates, emphasizing the importance of accurate forecasts in investment valuation.

References

• Brealey, R. A., Myers, S. C., & Allen, F. (2020). Principles of Corporate Finance (13th ed.). McGraw-Hill Education.
• Damodaran, A. (2012). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset. Wiley.
• Fabozzi, F. J. (2013). Bond Markets, Analysis and Strategies. Pearson.
• Gordon, M. J. (1959). Dividends, Earnings, and Stock Prices. Review of Economics and Statistics, 41(2), 99–105.
• Ross, S. A., Westerfield, R. W., & Jaffe, J. (2019). Corporate Finance. McGraw-Hill Education.
• Investopedia. (2021). Dividend Discount Model (DDM). https://www.investopedia.com/terms/d/dividenddiscountmodel.asp
• Higgins, R. C. (2012). Analysis for Financial Management. McGraw-Hill Education.
• Brigham, E. F., & Ehrhardt, M. C. (2013). Financial Management: Theory & Practice. Cengage Learning.
• Franklin, G., & Grauer, R. R. (2020). Fundamentals of Financial Management. Pearson.
• Lim, S., & Wong, K. (2018). Valuation of Growth Stocks: A Malaysian Perspective. Asian Journal of Finance & Accounting.