Question

The market consensus is that Analog Electronic Corporation has an ROE = 24%, a beta of 2.25, and plans to maintain indefinitely its traditional plowback ratio of 2/5. This year’s earnings were $3.90 per share. The annual dividend was just paid. The consensus estimate of the coming year’s market return is 16%, and T-bills currently offer a 6% return

A) Find the price at which Analog stock should sell

B) Calculate the P/E ratio

C) Calculate the present value of growth opportunities

D)  Suppose your research convinces you Analog will announce momentarily that it will immediately change its plowback ratio to 3/5. Find the intrinsic value of the stock

Answer 1

Solution:
ROE	24%
Beta	2.25
Plowback ratio	2/5
Earnings per share	$3.90
Market rate of return	16%
T-Bill	6%
A) Price at which Analog stock would sell:
Required return = Risk free rate + Beta(Market rate of return - Risk free rate)
6%+2.25(16%-6%)
0.285
28.50%
Required return i.e Ke = 28.50%
Growth rate = Plowback ratio * ROE
2/5*24%
0.096
Growth rate = 9.6%
Expected dividend = Current Dividend*(1+Growth rate)
$2.34*(1+0.096)
Expected dividend = $2.56464
Current dividend = Earning per share * 3/5
$3.90*3/5
2.34
Current dividend = $2.34
Current price = Expected dividend/(Ke-g)
$2.56464/(28.50%-9.6%)
13.56952381
The Price at which Analog stock would sell is $13.57
B)
Leading PE Ratio:
PE Ratio:
PE Ratio = Current price/Expected earnings per share
$13.56952381/4.2744
3.174603175
PE Ratio = 3.17
Earning per share = Earning per share*(1+Growth rate)
$3.90*(1+0.096)
4.2744
Trailing ratio:
PE Ratio:
PE Ratio = Current price/Earnings per share
$13.56952381/$3.90
3.479365079
PE Ratio = 3.48
C)
Present value of Growth opportunity:
PVGO = Current price - (Expected earnings /Ke)
$13.56952381 - (4.2744/0.285)
-1.428370927
$1.42837
D) Intrinsic value of stock:
A) Price at which Analog stock would sell:
Required return = Risk free rate + Beta(Market rate of return - Risk free rate)
6%+2.25(16%-6%)
0.285
28.50%
Required return i.e Ke = 28.50%
Growth rate = Plowback ratio * ROE
3/5*24%
0.144
Growth rate = 14.4%
Expected dividend = Current Dividend*(1+Growth rate)
$1.56*(1+0.144)
Expected dividend = $1.78464
Current dividend = Earning per share * 2/5
$3.90*2/5
1.56
Current dividend = $1.56
Current price = Expected dividend/(Ke-g)
$1.78464/(28.50%-14.4%)
12.65702128
The Price at which Analog stock would sell is $12.66