Question

1.AWK a public trade water utility company, has a Beta of .24. the most recent 10 year treasury yield is 3.15%. what is the required rate of return on this company? Please use historical average market premium to answer the question. 2.suppose AWK paid $2 dividend in the past 12 month and its dividend is supposed to grow at 2% per year for ever. what would be a reasonable estimate of AWK's stock price based on the dividend discount model? 3.now assume AWK's dividend will grow at 2.5% in the first 3 years and after 3 years it will grow at 2%. what would be a reasonable estimate of AWK's stock price based on the two stage dividend discount model?

4. instead of dropping suddenly from 2.5% to 2% in one year. lets assume that the growth rate AWK gradually decrease from 2.5% to 2%. please estimate AWK's stock price based on the H model.

5. AWK's earning per share in the past 12 month was $3.43. what would be a justified P/E ratio of AWK? used info from 1, 2 and 3

Answer 1

1]

the historical average market premium has been around 5.5%. We will use this in our calculations.

required return = risk free rate + (beta * historical average market premium)

required return = 3.15% + (0.24 * 5.5%)

required return = 4.47%

2]

stock price = current dividend * (1 + constant growth rate) / (required return - constant growth rate)

stock price = $2 * (1 + 2%) / (4.47% - 2%)

stock price = $82.59

3]

stock price = present value of next 3 years dividends + present value of terminal value at end of 3 years

terminal value at end of 3 years = year 3 dividend * (1 + growth rate after 3 years) / (required return - growth rate after 3 years)

present value = future value / (1 + required return)^{number of years}

stock price = $84.55

4]

price of stock = ((current dividend * (1 + growth rate after 3 years)) + (current dividend * H * (growth rate upto 3 years - growth rate after 3 years)) / (required return - growth rate after 3 years)

where H = transition period, which is 3 years.

price of stock = (($2 * (1 + 2%)) + ($2 * 3 * (2.5% - 2%)) / (4.47% - 2%)

price of stock = $83.81