Question

Consider the following information which relates to a given company:

Item	2019 Value
Earnings Per Share	$6.96
Price Per Share (Common Stock)	$41.68
Book Value (Common Stock Equity)	$56	Million
Total Common Stock Outstanding	2.3	Million
Dividend Per Share	$3.73

                                                                              

Analysts expect that the company could maintain a constant annual growth rate in dividends per share of 6% in the future, or possibly 9% for the next 2 years and 7% thereafter. In addition, it is expected that the risk of the firm, as measured by the risk premium on its stock, to increase immediately from 8.1% to 12%. Currently, the risk-free rate is 5%.

Required: (a) Determine the firm’s current book value per share.

(b) Determine the firm's P/E ratio.

(c) Determine the current required return for the firm's stock.

(d) Determine the new required return for the firm's stock.

(e) Assuming no growth in future dividends, and a required return of 16.09%, find the value per share of the firm's stock.

(f) Assuming a constant annual 6% growth rate in future dividends, find the value per share of the firm's stock. The required return is 16.09%.

(g) Assuming a constant annual 9% growth rate in dividends per share over the next two years and 7% thereafter, find the value per share of the firm's stock. The required return is 16.09%.

Answer 1

(a) Current Book Value per share = Book Value of Equity / Total common stock outstanding = 56 / 2.3 = $ 24.347

(b) P/E ratio = Market price per share / Earning price per share = 41.68/6.96 = 5.98

(c) Current required return for the firm's stock = 5% + 8.1% = 13.1%

Explanation

We will apply Capital Asset pricing model (CAPM) to calculate the required rate of return

= Risk free rate of return + (Betasecurity / BetaMarket) [ Return from Market - Risk free rate of return ]

Please note that Betamarket is always assumed as 1

Risk premium of security / security specific risk = Betasecurity [ Return from Market - Risk free rate of return ] = 8.1% given to us

(d) New equired return for the firm's stock = 5% + 12 % = 17%