Question

The current risk-free rate is 4 percent and the market risk premium is 6 percent. You are trying to value ABC company and it has an equity beta of 0.7. The company earned $3.00 per share in the year that just ended. You expect the company's earnings to grow 4 percent per year. The company has an ROE of 12 percent.

What is the value of the stock? Do not round intermediate calculations. Round your answer to the nearest cent.

$  

What is the present value of the growth opportunity? Do not round intermediate calculations. Round your answer to the nearest cent.

$  

Answer 1

Answer 1)

Retention Ratio = Growth Rate / ROE

= 4% / 12%

= 0.33 OR 33%

Payout Raio = 100% - 33% = 67%

Dividend = Payout Ratio * Earnings

= 0.67 * 3

= 2.01

Required Return as per CAPM = Rf + Beta * (Risk Premium)

= 4% + 0.70 * 6%

= 8.20%

Value of Stock = D 0 * (1+G) / Required Return - G

= 2.01 * (1+0.04) / 0.0820 - 0.04

= 49.77

Answer 2)

PVGO = Stock Price - Earnings / Required Return

= 49.77 - 3 / 0.082

= 13.18