Assume that the constant growth rate dividend discount model can be applied. You are given that...

Assume that the constant growth rate dividend discount model can be applied. You are given that the present value of growth opportunities (PVGO) for a firm is $5 per share. Its beta is 2.25, and it expects to earn $2 per share next year. The risk-free rate is 2% per year and (EM –Rf), the market risk premium is 8%. The firm’s earnings and dividends are expected to grow at 10% per year in perpetuity.(2 points each for a total of 16 points)

(a).Work out the market capitalization rate for this firm.

(b).Work out the Price of the firm’s stock

.(c).Work out the forward looking Price Earnings ratio for the firm.(

d).Work out the retention ratio for the firm.

(e).Work out the return on the book value of equity for this firm.

(f).Work out the book value of equity per share for this firm.

(g).Work out the Price to book ratio for this firm.(

h).What other information will you need to be able to work out the Price to Revenues ratio for the firm?

Expert Solution

Given details of the stock
Stock beta =2.25
Risk Free rate =2% pa
Market Risk premium=8%
So required return =2%+2.25*8%
Required return of stock=20%
So Market Capitalization rate =20%	Ans a.
Next Year Dividend=D1=$2 per share
Dividend growth rate =g=10% in perpetuity
Cost of Equity =k=20%
As per dividend discount Model,
Price of share =P0=D1/(k-g)=2/(20%-10%)=2/10%=	20.00
So the stock Price =$20	Ans b.
Assume Earing per share =P (with 100% dividend payout)
PVGO=Share Price -Share Price with no growth=Share Price -Earning per share(with 0% retention)/Cost of Equity
PVGO=5=20-P/0.2
P/0.2=15
P=3
So Earning per share for next year =$3
Dividend =$2
Retention /share =$1
So Retention ratio=1/3=33.33%	Ans d

Now Next years' Earning per share =$3
Current Market Price/share =$20
So Forward looking P/E =20/3=6.67	Ans c.

Now growth rate =ROE*Retention rate
10% =ROE*33.33%
ROE=30%
Return on book value of Equity =30%	Ans e.

Assume Book Value =B
So , B*30%=3
B =10
So book Value per share =$10	Ans f

Price to Book ratio/share =20/10=2	And g.

Ans h.
Price to revenue ratio= Market value per share/ Sales revenue per share.
To get that wratio we need the Sales revenue and no of shares outstanding.

ekkarill92 answered 2 years ago

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