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Question:

Beth Knight, CFA, and David Royal, CFA, are independently analyzing the value of Bishop, Inc. stock. Bishop paid a dividend of SI last year. Knight expects the dividend to grow by 10% in each of the next three years, after which it will grow at a constant rate of 4% per year. Royal also expects a temporary growth rate of 10% followed by a constant growth rate of 4%, but he expects the supernormal growth to last for only two years. Knight estimates that the required return on Bishop stock is 9%, but Royal believes the required return is 10%. Royal’s valuation of Bishop stock is approximate:

A
$5 less than Knight’s valuation.

Explaination

You can select the correct answer without calculating the share values. Royal is using a shorter period of supernormal growth and a higher required rate of return on the stock. Both of these factors will contribute to a lower value using the multistage DDM.

Knight: $1367_w447_h43.png$

Royal: $6645_w351_h43.png$

Royals valuation is $5.10 less than Knights valuation

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