Question

Jessica, Linda, and Wayne co-manage a large global equity portfolio. They are researching Google (GOOGL) , as of January 1, 2016. The current stock price is $200. The most recent quarterly dividend was $0.50 per share. Over the coming year, one more quarterly dividend of $0.50 is expected, followed by three quarterly dividends of $0.85. Using the CAPM, Jessica and Wayne estimate that GOOGL’s required rate of return is 5 percent. They have set a one-year target price for GOOGL of $315. Ignoring returns from reinvesting quarterly dividends: SHOW YOUR WORK

A.   What is their one-year expected return?

B.    What is the target price that is MOST consistent with GOOGL being fairly valued as of January 1, 2016?

Answer 1

Their cash flows from buying & holding the stock for the 4 quarters are tabulated as follows:

Quarter	0	1	2	3	4
Purchase price of GOOGL stock	-200
Dividend Cash flows		0.5	0.85	0.85	0.85
Target price at end of 4th qtr.					315
Total CFs	-200	0.5	0.85	0.85	315.85

Equating the stock's Cash outflows & inflows at r% per quarter,

200=(0.5/(1+r)^1)+(0.85/(1+r)^2)+(0.85/(1+r)^3)+(315.85/(1+r)^4)

& Solving for, we get the quarterly r as 12.3439%

the annual r being,

(1+12.3439%)^4-1=

59.29%

Answer to A.---59.29% p.a. is their one-year expected return

B. Target price that is MOST consistent with GOOGL being fairly valued as of January 1, 2016

is the future value of its current price PLUS all its dividned cash flows at end of the 4th quarter , at 5% /4=1.25% or 0.0125 per quarter

(200*1.0125^4)+(0.50*1.0125^3)+(0.85*1.0125^2)+(0.85*1.0125^1)+0.85=

213.29

(Answer)