How Loww Can It Go

1. Basically, the value of any securities is worth the present value of all future cash flow the owner which will receive.

For stockholders, future cash flow that they will receive is in the form of dividend and the yield from selling of stocks. Therefore, if stockholders intend to hold stocks infinitely, we can value common stock by sum up present value of future dividend of company. This method is known as Dividend Discounted Model (DDM).

In its simplest form, the DDM uses, mathematically it can be expressed as:

Where Dt is the expected dividend in period t and k is the required rate of return for the investor.

Assumptions on this DDM are:

* Dividends are expected to be distributed at the end of each year until infinity.

* Dividends are the only way investors get money back from the company. This implies that any share buyback would be ignored.

* The implication of the second assumption is that the investor is expected to hold the share for an infinite period: he will not sell it, at any moment.

DDM - Pharmacopia Company Stocks:

By DDM we can see that the value of Pharmacopia common stocks is between $10 - $21. Based on that value, Jonathan should recommend Dwayne not to sell the stocks until it get a better price.

2. We can calculate the growth rate of dividend by 2 approach:

a. Historical data

Growth (g) = Return on retained earnings X Retention ratio

The equation assumes a constant Return on RE and payout ratio. It implies that if a firm's Return on RE decreases, its ability to grow dividends will suffer. Conversely, if a firm improves its Return on RE, its dividends stand to rise. It's also implicit that firms with low payout ratios will grow their dividends more quickly than those already paying out a substantial percentage of their earnings.

Other support formula:

Return on R/E = Earning next year - Earning this year

R/E this year

Retention ratio = Retained earning this year

Earning this year

Retention ratio + Dividend Payout ratio = 1

Year Sales NI EPS DPS DPR RR Return on R/E g

1995 3,000 150 1.50 0.60 0.40 0.60 11.11% 6.67%

1996 3,200 160 1.60 0.64 0.40 0.60 41.67% 25.00%

1997 4,000 200 2.00 0.80 0.40 0.60 16.67% 10.00%

1998 4,400 220 2.20 0.88 0.40 0.60 15.15% 9.09%

1999 4,800 240 2.40 0.96 0.40 0.60 6.94% 4.17%

2000 5,000 250 2.50 1.00 0.40 0.60 6.67% 4.00%

2001 5,200 260 2.60 1.04 0.40 0.60 -3.21% -1.92%

2002 5,100 255 2.55 1.02 0.40 0.60 -6.54% -3.92%

2003 4,900 245 2.45 0.98 0.40 0.60 -6.80% -4.08%

2004 4,700 235 2.35 0.94 0.40 0.60

Average g 5.44%

Note: DPR : Dividend Payout Ratio

RR : Retention Ratio

b. Industry growth rate. It is assumed that Dividend growth is consistent with growth of industry.

3. RR that Jonathan used is based on assumption that investor want a return which equal to risk free rate plus premium for them because of their decision to take some risk by investing in stocks.

RR is calculated = Risk free + (market risk premium*beta)

R = RF + в