Question

4. You have been recently appointed as a corporate manager in EXIM Bank Malaysia. Your new corporate client, the Limkokwing University of Creative Technology Sdn. Bhd. Malaysia, has requested from you to present an investment seminar to the staff of University. To illustrate the corporate processes, you have to analyze the performance of PETRONAS BHD Malaysia. The following “interesting” questions have been raised:

a) If PETRONAS BHD Malaysia has a beta coefficient of 0.9, the risk-free rate is 3%, and the required rate of return on the market is 10%, what would be company’s appropriate required rate of return?

b) PETRONAS BHD Malaysia is a constant growth company whose last dividend was RM1.60. Dividends are expected to grow indefinitely at a 4% rate. What is the company’s expected dividend stream over the next 4 years?

c) What would be current stock price of PETRONAS BHD Malaysia?

d) What would the stock price be if its dividends were expected to have zero growth?

e) Assume that PETRONAS BHD Malaysia is expected to experience non-constant growth of 20% for the next 3 years, then to return to its long-run constant growth rate of 4%. What is the stock’s value under these conditions?

f) Lastly, PETRONAS BHD Malaysia issued 25 years corporate bonds. Bond A has been issued 5 years ago, paying 8% interest semi-annually. Bond B has been issued 10 years ago, paying 6% interest quarterly. The bond market rate is 7%. Which bond will be more attractive to the potential buyers? Explain your answer.

Answer 1

(a) Market Rate of Return = 10 %, Risk-Free Rate = 3 % and Beta Coefficient = 0.9

Using CAPM, required return on equity = 3 + 0.9 x (10 - 3) = 9.3 %

(b) Current Dividend = D0 = RM 1.6 and Dividend Growth Rate = 4 % to perpetuity

Dividend Stream: D1 (dividend after Year 1) = 1.04 x 1.6 = RM 1.664

D2 = 1.664 x 1.04 = RM 1.73056

D3 = 1.73056 x 1.04 = RM 1.7997824

D4 = 1.7997824 x 1.04 = RM 1.871773696

(c) Let Current Stock Price be P0 , dividend growth rate = g = 4 %, Required Return = r = 9.3 % and D1 = 1.664

Therefore, P0 = D1 / (r - g) = 1.664 / (0.093 - 0.04) = RM 31.396

(d) In case of zero growth g = 0 and dividend would be RM 1.6 perpetually.

Therefore, stock price = 1.6 / 0.093 = RM 17.204

NOTE: Please raise separate queries for solutions to the remaining unrelated questions.