Question

1. Consider the following data for Verizon (VZ):

• Price as of 12/31/2018 = 56.25
• Earnings for 2019 = 3.90
• Earnings projected for 2020 = 4.95
• Beta = 0.5

Additionally, you know the following information about the market: The risk free rate of return in the market is 2.5%, and the expected return on the market is 10.5%.

Using this information, provide a price estimate for Verizon currently. As you do this, you should note that you will need to make an assumption about PVGO (and note what this assumption is, consider how likely it is to be true, and what happens if this assumption is violated). Additionally, you will need to use the CAPM. Once you have a price estimate, compare your price estimate to VZ’s current price (which you will need to look up on a financial news site). Based on your comparison, should you buy or sell (short) the stock?

Then consider how things would shift if you observed the following changes:

• How would your answer change if the PVGO declines to -$17?
• If instead of a decline in PVGO, we saw VZ’s required rate of return shift to 10%, what happens to the PVGO and the price of the stock?
  • Do these things shift in the same direction? Why might the shift we see make sense? Hint: For this last question, think about what an increase in the required rate of return signifies.

Answer 1

Rf	2.50%
Rm	10.50%
Beta	0.50
31-12-2018
	Price	56.25
31-12-2019
	Earning for 2019	3.9
	Price	Required
	Re	Rf+ Beta (Rm-Rf)
	Re	(2.5+0.5(10.5-2.5))
	Re	6.50%
Assuming the Present Value of Growth Opprtunities is not yeliding a return of more than 6.5% and hence the entire projected earnings of 2020 will be distributed as dividends
	Price (Dividend Growth Model)	4.95/6.5%	76.15
If the assumption is violated and say the company forsees a positive PVGO over the expected Returns of 6.5%, then the company may not pay dividends or pay less dividends.
In that case, we also need to assume the growth rates.
Lets take the below scenarios.
	Dividend Payout	Growth Rate	Price
A	20%	5%	(4.95*20%)/(6.5-5)%	66.00
B	60%	3%	(4.95*60%)/(6.5-3)%	84.86