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The risk free rate of return is 3%, the expected return on themarket portfolio is...

The risk free rate of return is 3%, the expected return on the market portfolio is 11% and the stock of Xyr Corp has a beta coefficient of 1.2. Kyr pays out 35% of its earnings in dividends and the latest earnings announced were $7.50/share. Dividends were just paid and are expected to be paid annually. You expect that Xyr will earn an RoE of 19% per year on all reinvested earnings forever.

a. What is the intrinsic value of a share of Xyr stock?

Solutions

Expert Solution

Growth rate, g = ROE * (1 - payout ratio)

g = 0.19 * (1 - 0.35)

g = 0.1235

The required rate of return (re) using CAPM

re = 0.03 + 1.2 * (0.11 - 0.03)

re = 0.126

D0 = Latest earnings * Payout ratio

D0 = 7.50 * 0.35

D0 = $2.625

D1 = D0 * (1 + g)

D1 = 2.625 * (1 + 0.1235)

D1 = 2.9491875

The intrinsic value = D1/(re - g)

The intrinsic value = 2.9491875/(0.126 - 0.1235)

The intrinsic value = $1,179.675

jeff jeffy answered 2 years ago
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