Question

The board of directors of API, a relatively new electronics manufacturer, has decided to begin paying a common stock dividend to increase the attractiveness of the stock in the free market. The board plans to pay $2.45 per share in the coming year (i.e., next year) and anticipates that its future dividends will increase at an annual rate consistent with that experienced over the period from 2013 - 2016 (see below). The company currently has a beta of 1.5, the rate of return for the market is expected to be 8% and the risk-free rate is currently 3%. Given this scenario, what is the current value of API's common stock? If the current market price is $48.00 per share, should you purchase this stock. Briefly, explain your answer. (HINT: This problem requires a three-part calculation to solve it). USE MS EXCEL TO CONDUCT YOUR CALCULATIONS (embed your calculations in the cells and do NOT round your interim calculations, rather use links between the cells), then post your spreadsheet using this link (Textbook Assignment 2).

Year Dividend

2016 $2.32

2015 $2.21

2014 $2.10

2013 $2.00

Answer 1

FV = PV (1+r)^n

FV = Future Value

PV = Present Value

r = Growth

n = no of years

2.32 = 2 *(1+r)^3

2.32 /2 = (1+r)^3

1.16 = (1+r)^3

1.16^(1/3) = 1+r

1.051 = 1+r

r = 1.051 -1

r = 0.051

i.e., 5.1%

Ke = Rf +Beta (Rm-Rf)

= 3 +1.5(8-3)

= 3 +1.5*5

= 3+7.5

= 10.5

P0 = D1/ (ke-g)

= 2.45 /(0.105 - 0.051)

= 2.45 / 0.054

= $ 45.37

If the current Market price is $ 48, the stock is over priced, it is not advisable to purchase the stock

Pls do rate, if the answer is correct and comment, if any further assistance is required.