Question

Solve these questions with formula (answer quantitatively) :

a.. Chris Rogers forecasted that Android Inc shall pay its first dividend 2 years from now worth $1.5. For the year after that, it has been forecasted that a dividend of $2.2 shall be paid. This will grow a constant growth rate of 5%. The Risk free rate is 4%, market risk premium is 6% and beta is 1.2 . What is the value of the share of Android?

b. Heather Callaway, CFA, is concerned about the accuracy of her valuation of Crimson Gate, a fast growing telecommunications equipment company that her firm rates as a top buy. Crimson currently trades at $134 per share, and Callaway has put together the following information of the stock :
Most recent dividend per share = $0.55
Growth rate, next 2 years = 30%
Growth rate , after 2 years = 12%
Trailing P/E = 25.6
Financial leverage = 3.4
Sales = $1198 per share
Asset turnover = 11.2
Estimated market rate of return = 13.2%
Callaway's employer, Bates Investment, likes to use a company's sustainable growth rate as a key input to obtaining the required rate of return for the company's stock. Crim son's sustainable growth rate is ?

Answer 1

a). Cost of equity k (using CAPM) = risk-free rate + (beta*market risk premium) = 4% + (1.2*6%) = 11.20%

Value per share can now be found using the dividend growth model, as follows:

Formula	Year (n)	1	2	3	Perpetuity
	Growth rate (g)				5%
	Dividend (D)	-	1.50	2.20	2.31
Dperpetuity/(k-g)	Perpetuity cash flow				37.26
	Total cash flow (CF)	-	1.50	2.20	37.26
1/(1+k)^n	Discount factor @ 11.20%	0.899	0.809	0.727	0.727
(CF*Discount factor)	PV of CF	-	1.213	1.600	27.096
Sum of all PVs	Value per share	29.909

b). Sustainable Growth Rate (SGR) = retention ratio * ROE

P/E = 25.6 and P =134 so E = 134/25.6 = 5.23

Retention ratio = (Earnings -dividend)/Earnings = (5.23-0.55)/5.23 = 0.89 or 89%

ROE = profit margin*asset turnover*financial leverage ratio

= (5.23/11.98)*11.2*3.4 = 16.62%

SGR = 89%*16.62% = 14.8%