Question

FIN303: Financial Management

Company ABC has just announced earnings of $2 per share. Based on the last five years, earnings have grown at a rate of 20% per annum and the company expects this to continue for the next five years, after which it expects earnings to remain constant forever. The company has a policy of paying out 30% of its earnings as dividends. ABC stock has a beta of 1.2. The yield to maturity on 10-year government bonds is 2% and market risk premium is 10%.

Required:

(a) Calculate the current value per share.

Answer 1

As per CAPM	Re= Rf+Beta(Rf-Rm)	Re=2%+1.2*10%
Rf=2%		Re= 14%
Rf-Rm=10%		Reqiured rate of return for investor Ke=14%
Beta= 1.2

A	B	C	D	E
Year	EPS growing @ 20%(EPS*1.20)	DPS @ 30% of EPS	Discounting rate @14%	PV of dividends(C*D)
0	2
1	2.40	0.72	0.8772	0.63
2	2.88	0.86	0.7695	0.66
3	3.46	1.04	0.6750	0.70
4	4.15	1.24	0.5921	0.74
5	4.98	1.49	0.5194	0.78
				3.51

After the 5th year there will be no growth and perpertual dividend will be paid thoughout= 1.49

Hence value of share at the end of year 5 = 1.49/.14= $10.64

current value per share = $10.64 *(PV 14%,5 years) + PV of dividends= $10.64*0.5194+3.51= $9.037