Question

a) Bolton invested $100,000 in Amway shares. Other information as below:
Company beta - 1.5 Government Treasury bill – 5%

He seeks your advice on the value of share if the NYSE return is 30% during the year.

b) Ramli Bhd is expected to pay a RM0.50 dividend next year. The dividend is expected to grow at 30% annual rate for Year 2 and 3, at 20% annually for Year 4 and 5, and at 5% annual rate for Year 6 Thereafter. If the required rate of return is 10%, what is the value per share?         

Answer 1

a)

CAPM equation:

Rs=Rf+Beta*(Rm-Rf)

Rf=Risk free rate =5%

Beta=1.5

Rm=Market Return=30%

Rs=5+1.5*(30-5)=42.5%

The stock is likely to give a return of 42.5% , if NYSE return is 30%

b)

D1=Next year Dividend (Year1)=0.50

Growth rate in year 2 and 3 =g1=30%=0.3

Growth rate in year 4 and 5 =g2=20%=0.2

Growth rate in year6 onwards=g=5%=0.05

Required Return=R=10%=0.1

D2=Year 2 Dividend =D1*(1+g1)=0.50*1.3=0.65

D3=Year 3 Dividend =D2*(1+g1)=0.65*1.3=0.845

D4=Year 4 Dividend =D3*(1+g2)=0.845*1.2=1.014

D5=Year 5 Dividend =D4*(1+g2)=1.014*1.2=1.2168

D6=Year 6 Dividend =D5*(1+g)=1.2168*1.05=1.27764

Price in Year 5=P5=D6/(R-g)=1.27764/(0.1-0.05)=25.55

Present Value of Dividend Stream=(0.50/1.1)+(0.65/(1.1^2))+(0.845/(1.1^3))+(1.014/(1.1^4))+(1.2168/(1.1^5))=3.07

Horizon Value=Price in Year 5=P5=25.55

Present Value of Horizon Value=25.55/(1.1^5)=15.87

Value per share=Present Value of future cash flows=3.07+15.87=18.94