Nextbig Corp. currently has sales of $870 million; sales are expected to grow by 26% next year (year 1). For the year after next (year 2), the growth rate in sales is expected to equal 13%. Over each of the next two years, the company is expected to have a net profit margin of 11% and a payout ratio of 40% and to maintain the common stock outstanding at 24 million shares. The stock always trades at a P/E of 15 times earnings, and the investor has a required rate of return 18%. Given this information:

1. Find the stock's intrinsic value (its justified price).
2. Use the IRR approach to determine the stock's expected return, given that it is currently trading at $38 per share.
3. Find the holding period returns for this stock for year 1 and for year 2.

(1) Intrinsic value = 64.5

(2) IRR = 54.35%

(3) Holding period yield

Year - 1 = 103.61%

Year - 2 = 16.02 %

Step-by-step explanation

Step - (1)

Compute some basic calculations needed to answer the list of questions

Current sales = 870 million

Current Net Income = 870 * 11 % = 95.7 Million

D0 = Current dividend per share = 95700000 * 0.40/ 24000000  = 1.595

D1 = D0 * ( 1,26 ) = 1.595 * (1.26 ) = 2.0097 ( first year growth rate = 26 %)

D2 = D1 * (1.13) = 2.0097 * (1.13) = 2.270961 ( second year growth rate = 13%)

E1 = Earnings for year - 1 = 870 * 0.11 * 1.26 / 24 = 5.02425

E2 = Earnings for year - 2 = 5.02425 * (1.13)  = 5.6774025

P1 = Price of the share end of year - 1 = E1 * P/E ratio  = 5.02425 * 15 = 75.36375

P2 = Price of the share end of year - 2 = E2 * P/E ratio  = 5.6774025 * 15   = 85.1610375

Step - (2) Solve each of the questions

Question - (1)

Intrinsic value per share = D1 / (1 +Ke) + D2 / (1+Ke)² + P2 /(1+Ke)²

= 2.0097 / (1.18) + 2.270961 /(1.18)² + 85.1610375 / (1.18)²

= 64.50

Question - (2 )

Year - 0 = - 38 because, current market price is an investment and cash out flow

Year - 1 = 2.0097 is a dividend and cash inflow

Year - 2 = D2 + P2 =2.270961+85.1610375 = 87.432

IRR = 54.35%

Question - 3

Holding period yield = [( P1 - P0) + D1 ]/ P0 * 100

Year - 1 = [( 75.36375 - 38 ) + 2.0097 ]/ 38 * 100 = 103.61%

Year - 2 = [ ( 85.16 - 75.36 ) + 2.270961 ] / 75.36 * 100 = 16.02 %

Please see the attached file for the complete solution