Let\'s assume that? you\'re thinking about buying stock in West Coast Electronic
ID: 1170288 • Letter: L
Question
Let's assume that? you're thinking about buying stock in West Coast Electronics. So far in your? analysis, you've uncovered the following? information: The stock pays annual dividends of $5.45 a share indefinitely. It trades at a? P/E of 11.5 times earnings and has a beta of 1.15. In? addition, you plan on using a? risk-free rate of4.00?%in the? CAPM, along with a market return of 11?%.You would like to hold the stock for 3? years, at the end of which time you think EPS will be $8.76 a share. Given that the stock currently trades at $76.02, use the IRR approach to find this? security's expected return. Now use the dividend valuation model? (with constant? dividends) to put a price on this stock. Does this look like a good investment to? you? Explain.
A. This? security's expected return? (IRR) is ____% (round to two decimals)
B. The value of the stock is $ ____ (nearest cent)
C. Using the dividend valuation model? (with constant? dividends), the value of the stock is ?$ ___ (Nearest cent)
D.
Does this look like a good investment to? you? Explain. ? (Select the best choice?below.)
A.
?No, the stock looks like it would not make a good investment. It has a justified price that is below its current market? price, and its expected return is lower than the required return.
B.
?No, the stock looks like it would not make a good investment. It has a justified price that is above its current market? price, and its expected return is higher than the required return.
C.
?Yes, the stock looks like it would make a good investment. It has a justified price that is below its current market? price, and its expected return is lower than the required return.
D.
?Yes, the stock looks like it would make a good investment. It has a justified price that is above its current market? price, and its expected return is higher than the required return.
Explanation / Answer
a) Calculation of IRR
IRR = risk free rate + beta(market return)
= 4%+ 1.15(11%)
=4%+12.65%
=16.65%
b) value of stock
Value of stock is nothing but present value of all dividend plust curent stock price
Value of stock = PV of dividend+ PV of stock price at end of year 3
=5.45/(1+16.65%) + 5.54/(1+16.65%)^2 + 5.54+100.74/(1+16.65)^3
=5.45/1.1665 + 5.54/1.3607 + 106.28/1.5873
=4.672 + 4.07136 + 66.95647
=75.7$
c) CAPM = risk free rate + b(market premium)
=4%+1.15(11%-4%)
=4%+8.05%
=12.05%
Vlaue of stock = Dividend/Expected return
=5.45/12.05%
=45.22$
D) Ans B) No, the stock looks like it would not make a good investment. It has a justified price that is above its current market? price, and its expected return is higher than the required return.
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