Question

Q3.  SAR​ company’s ordinary shares are expected to pay​ $1.8 per share in dividends in 2 years and after which the dividends are expected to grow at 2% annually forever. Company​ ABC's shares have a beta of 1.1. The​ long-term return of ASX200 is ​9.4% and the return of​ T-bonds is 3.4 ​%.

a.What is the expected return of​ SAR’s shares according to the​ CAPM?

b.What is the implied price per​ share

Answer 1

(a)As per CAPM, Expected Return of SAR share = Risk free rate + Beta*(Market return - Risk free rate)

where, Risk free rate = 3.4%

Market return= 9.4%

Beta = 1.1

So,Expected Return of SAR share = 0.034 + 1.1*(0.094 - 0.034)

Expected Return of SAR share = 0.034 + (1.1*0.06) = 10%

(b) Dividend paid in 2 years' time = $1.8 per share

Dividend growth rate = 2% per annum

Discount rate = expected return of SAR stock = 10%

Now, Terminal value = Dividend in 2nd year*(1+ growth rate)/(Discount rate - Growth rate)

Terminal value = 1.8*(1+0.02)/(0.1 - 0.02) = $22.95

So, the cash-flow looks like

years	1	2	2
Cash-flow	0	1.8	22.95

Calculating the present value using 10% as the discount rate

PV = Cash flow of each period/(1+discount rate)^time where time = 1,2

years	1	2	2
Cash-flow	0	1.8	22.95
PV	0.00	1.49	18.97
Total PV	20.45

So, the implied price per share =$20.45