Question

ABC corp. has an ROE of 12%. It's forecasted next period earning is $10/share and dividend is $7/share. Assume the cost of capital is 10%. What's the PVGO for ABC corp.?

Stock A and stock B are in the same industry and are competitors to each other. Stock A's return in the past 10 years has a standard deviation of 5%, and stock B's return in the past 2 years has a standard deviation of 3%. Assume they are performing as well as each other, which one is more likely to be undervalued?

Stock A

Stock B

Cannot tell

Stock A and stock B are in the same industry and are competitors to each other. Stock A has a dividend yield of 5%, and stock B has a dividend yield of 10%. Assume they are performing as well as each other, which one is more likely to be undervalued?

Stock A

Stock B

Cannot tell

Stock A and stock B are in the same industry and are competitors to each other. Stock A has a P/E ratio of 20, and stock B has a P/E ratio of 5. Assume they are performing as well as each other, which one is more likely to be undervalued?

Stock A

Stock B

Cannot tell

Answer 1

Answer to Question 1:

Payout Ratio = Next Year Dividend / Next Year Earnings
Payout Ratio = $7.00 / $10.00
Payout Ratio = 0.70

Retention Ratio = 1 - Payout Ratio
Retention Ratio = 1 - 0.70
Retention Ratio = 0.30

Growth Rate = ROE * Retention Ratio
Growth Rate = 12% * 0.30
Growth Rate = 3.60%

Cost of Capital = 10.00%

Price with Growth = Next Year Dividend / (Cost of Capital - Growth Rate)
Price with Growth = $7.00 / (0.10 - 0.036)
Price with Growth = $7.00 / 0.064
Price with Growth = $109.38

Price without Growth = Next Year Earnings / Cost of Capital
Price without Growth = $10.00 / 0.10
Price without Growth = $100.00

Present Value of Growth Opportunities = Price with Growth - Price without Growth
Present Value of Growth Opportunities = $109.38 - $100.00
Present Value of Growth Opportunities = $9.38