ABC Corp. has an ROE of 8% and reinvests 40% of its net income. ABC has just paid an annual dividend of $0.25.
ABC stock has a beta of 1.1. The risk-free rate is 2.8% and the expected return on the market portfolio is 7%.
What is the appropriate discount rate?
What is the expected growth rate of dividends?
What is the intrinsic value (fair price) of ABC stock?
1)Discount rate = Rf + [Beta (Rm-Rf)]
= 2.8+ [1.1I(7-2.8)]
= 2.8 + [1.1*4.2]
= 2.8+ 4.62
= 7.42%
2)Growth =ROE * Retention ratio
= 8* 40%
=3.2%
3)Intrinsic value =D0(1+g)/(Rs-g)
=.25 (1+.032)/(.0742-.032)
= .25 *1.032/ .0422
= $ 6.11 per share
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