Question

You are valuing a bank. The bank currently has assets of $335 per share. Five years from now (that is, at the end of five years), you expect their assets per share to be $480. After Year 5, you expect their assets per share to grow at 3.75 percent per year forever. The bank has an ROA of 1.6 percent and an ROE of 13.0 percent. The bank's cost of equity is 12.0 percent. What is the value of the bank's stock? Use the free cash flow to equity model to value this stock. Do not round intermediate calculations. Round your answer to the nearest cent

Answer 1

Before proceeding

Lets understand what the question is asking and what are the steps

Question says calculate value of the bank's stock

Step1: Return on assets= Net income/total assets

Therefore Net income= Total assets*ROA

Hence we will use Net income and will find FREE CASH FLOWS FOR EQUITY for a period of 5 year discounting it at cost of equity i.e12%

Step2: growth= (Value of asset at the end of 5^th year-value of asset in the beginning/value of asset in the beginning)/n

A base year is used which is year ZERO that is today net income is taken which is 5.36 and a growth %age as calculated above 5.36*8.66%=0.464176 is added to net inflow every year.

Step3:It says that After 5^th year growth is 3.75% Forever

Hence terminal value will be calculated using formula

FCFE(1+g)/Ke-g

Now total value of Banks stock will be Present value of future cash inflows +Terminal value

Detailed solution Hence PRESENT VALUE OF BANk's STOCK=$84.13

Formula for above