Question

The board of directors of API, a relatively new electronics manufacturer, has decided to continue paying a common stock dividend to increase the attractiveness of the stock in the free market. The board plans to pay $2.20 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 2017 - 2020 (see below). The company currently has a beta of 1.2, the rate of return for the market is expected to be 8% and the risk-free rate is currently 5%. Given this scenario, what is the current value of API's common stock? If the current market price is $40.00 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 EMBED YOUR CALCULATIONS IN THE CELLS (do NOT round your interim calculations, rather use links between the cells), then post your spreadsheet using this link (Textbook Assignment 2). Year Dividend 2020 $2.12 2019 $2.04 2018 $1.96 2017 $1.88.

Answer 1

1]	Required return per CAPM = 5%+1.2*(8%-5%) =	8.60%
2]	Growth rate in dividends = (2.12/1.88)^(1/3)-1 =	4.09%
3]	Intrinsic value of the share using the constant dividend growth formula = 2.20/(0.086-0.0409) =	$            48.78
4]	As the theoretical [intrinsic] value of the share
	of $48.78 is higher than the current price of $48.00
	the share can be purchased.