Question

company recently paid its annual dividend of $3, and reported an ROE of 15%. The firm pays out 50% of its earnings as dividends. The stock has a beta of 1.28. The current risk-free rate is 2.6% and the market return is 9.6%. Assuming that CAPM holds, what is the intrinsic value of this stock?

Answer 1

Answer:

Retention ratio = 1 – Dividend Payout
Retention Ratio = 1 – 0.50
Retention Ratio = 0.5 or 50%

Growth Rate = ROE *Retention Ratio
Growth Rate = 0.15* 0.50
Growth Rate = 0.075 or7.5%

Required Return = Risk free rate + beta * (Market Return – Risk free rate)
Required Return = 0.026 + 1.28 *(0.096 - 0.026)
Required Return = 0.026 + 1.28 * 0.07
Required Return = 0.026 + 0.0896
Required Return = 0.1156

D1 = D0 * (1 + g)
D1 = $3 *(1 + 0.075)
D1 = $3.225

R =D1 /P0 + g
0.1156 = $3.225 / P0 + 0.075
0.1156 – 0.075 = $3.225 / P0
0.0406 = $3.225 / P0
P0 = $3.225 / 0.0406
P0 = $79.43