Question

You have been tasked to determine whether Raleigh Inc.’s stock is fairly priced. Raleigh Inc. currently has EBIT of $5M, $10M of debt outstanding at 9%, and a tax rate of 28%. Raleigh Inc. has consistently maintained a 55% payout ratio and you do not expect the firms payout ratio or EBIT to change in the future. The firm has a Beta of 1.2, the market risk premium is 10%, and treasury bills are currently yielding 4%. Raleigh Inc. has 500k shares outstanding. What is Raleigh Inc’s price per share?

Answer 1

Cost of equity= 16% as per CAPM, as follows:

Cost of equity (Re)= Rf + Beta* Rp   Where Rf= Risk free rate (treasury bill yield given as 4% and Rp= Market risk premium (given as 10%). Beta is 1.2

Re= 4%+1.2*10%= 16%

Given, EBIT=$5 Million.

Debt= $10 Million at 9%. Therefore, interest= $10 Million*9%= 0.9 Million

Tax rate= 28%. Tax= (EBIT-Interest)*28%= $2.548 Million.

Therefore, Profit after tax= $6.552 Million

Number of shares= 500k= 500,000. Payout ratio= 55%

Therefore, dividend per share= ($6.552 Million/500,000)*55% = $7.2072

It is stated that the EBIT and Payout ratio will remain unchanged. Hence growth rate off Dividend =0

Price per share= D1/r-g Where D1= next year dividend= $7.2072, r=16% and g=nil

Price per share= $7.2072/0.16= $45.045 Rounded to $45.05