In: Finance
Lockheed Martin Inc. a U.S. defense contractor producing ballistic missile defense systems, distributed dividends of $10 per share in 2019 on earnings per share of $15 per share. The book value of equity per share was $200, and earnings are expected to grow at a constant rate of 1% a year forever. The stock has an unlevered beta of 1.00, a debt to equity (D/E) ratio of 40%, and is currently trading at $150 per share. The current risk free rate is 1% and the implied equity risk premium is 5%. The corporate tax rate is 30%.
a Levered beta of Lockheed Martin Inc. |
Levered beta=Unlevered beta*(1+((1-Tax rate)*Debt/equity))) |
ie.1*(1+((1-30%)*40%))) |
1.28 |
(Answer) |
b.Cost of equity of Lockheed Martin Inc. |
as per CAPM, ke=RFR+(Beta*Market risk premium) |
ie.1%+(1.28*5%)= |
7.40% |
(Answer) |
c.Estimate of fair price based on the above |
we need to know the growth rate of dividends, to calculate the fair price ,ie. Intrinsic value per equity share--- |
Growth rate, g =Return on equity*Retention Ratio |
From the given details, we can calculate g, as |
g=(EPS/Book value Share)*((EPS-Dividends)/EPS) |
ie.(15/200)*((15-10)/15) |
7.50%*33.33% |
2.50% |
Now, the fair price of the share |
as per Gordon's constant growth of dividend cash flows, model |
P0=D1/(r-g) |
ie. (10*1.025)/(7.40%-2.50%)= |
209.18 |
So the |
Fair Price/Book Value ratio= |
209.18/200= |
1.0459 |
(Answer) |
d.Dividend per share($) Lockheed Martin Inc. should distribute to shareholders to justify the Price/Book Value ratio at which the firm is currently selling for, ie. $ 150 |
next dividend per share to be distributed is |
7.40%=(d1/150)+2.50% |
D1= $ 7.35 (Answer) |