Question
In: Finance
Linkedina has a ROE of 24% that is expected to stay like that for years 1...
Linkedina has a ROE of 24% that is expected to stay like that for years 1 to 3. In year 4 the ROE is expected to change to $12 (for both new and old projects) and stay there forever. The firm's stock has just paid a dividend of 6 AUD and the retention ratio is 40%. Assume the retention ratio is held constant forever and the opportunity cost of equity capital is 12$. What is your estimate of the value of a share of the firm?
a. 48
b. 81.8
c. -45.2%
d. 60.03
e. Cannot be determined
Solutions
Expert Solution
| 1) | Growth rate = ROE*Retention ratio | |||||
| Growth rate for Years 1 to 3 = 24%*40% = | 9.60% | |||||
| Growth rate from Year 4 onwards = 12%*40% = | 4.80% | |||||
| 2) | Value of a share of the firm is the PV of expected | |||||
| dividends. | ||||||
| The PV of dividends for Years 1 to 3 are calculated below: | ||||||
| Year | Expected Dividend | PVIF at 12% | PV at 12% | |||
| 0 | $ 6.00 | 1.00000 | ||||
| 1 | $ 6.58 | 0.89286 | $ 5.87 | |||
| 2 | $ 7.21 | 0.79719 | $ 5.75 | |||
| 3 | $ 7.90 | 0.71178 | $ 5.62 | |||
| PV of dividends t1 to t3 | $ 17.24 | |||||
| Continuing value of dividends at t3 = 7.90*1.048/(0.12-0.048) = | $ 114.99 | |||||
| PV of continuing value of dividends = 114.99*0.71178 = | $ 81.85 | |||||
| Value of the share = 17.24+81.85 = | $99.09 | |||||
ALL GIVEN OPTIONS ARE WRONG.
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