The market consensus is that Analog Electronic Corporation has an ROE = 15%, a b
ID: 1171635 • Letter: T
Question
The market consensus is that Analog Electronic Corporation has an ROE = 15%, a beta of 1.90, and plans to maintain indefinitely its traditional plowback ratio of 1/5. This year's earmings were $3.20 per share. The annual dividend was just pald. The consensus estimate of the coming year's market return is 16%, and T-bills currently offer a 5% return. a. Find the price at which Analog stock should sell. (Do not round Intermedlate calculations. Round your answer to 2 declmal places.) Price b. Calculate the P/E ratio. (Do not round Intermedlate calculations. Round your answer to 2 decimal places.) P/E Ratic Leading Trailing c. Calculate the present value of growth opportunities. (Negatlve amount should be Indicated by a minus sign. Do not round Intermediete calculetions. Round your answer to 2 declmal places.) PVGO d. Suppose your research convinces you Analog will announce momentarlly that It will Immediately change its plowback ratio to 4/5. Find the Intrinsic value of the stock. (Do not round Intermedlate calculetions. Round your answer to 2 declmel places.) sic valueExplanation / Answer
Solution:-
a) Ans:- $11.51
b) Ans:-Leading PE= 3.49
Trailing PE= 3.60
c)Ans:- -$1.22
d)Ans:-$5.16
Workings:-
a) Calculation of price of share
First calculate cost of equity using CAPM model (Ke)= Rf+Beta*(Rm-Rf)
= 5%+1.90*(16%-5%)= 25.90%
Growth rate (g)= ROE*retention ratio = 15%*0.2=3%
Last dividend paid( DPS0)=$3.20*4/5=$2.56
Using DDM , Price of the share
( P0) =DPS0*(1+g)()Ke-g)
= $2.56*1.03/(25.90%-3%)
=2.6368/22.9%= $11.51
b) Calculation of PE ratio
Leading PE ratio = P0/EPS1
=11.51/(3.2*1.03) =11.51/3.296=3.49
Trailing PE ratio =P0/EPS0= 11.51/3.20= 3.60
c) Present value of growth opportunities =
Price of share taking growth- Price without growth
=11.51(calculated above)-EPS1/RR
=11.51-3.2(1+0.03)/25.90% = 11.51-12.7258= -$1.22
d) If the retention ratio is changed to 4/5
Growth rate = ROE*Retention ratio= 15%*4/5= 12%
DPS0 will be = $3.20*1/5=$0.64
DPS1= DPS0*(1+12%)=0.64*1.12=0.7168
Intrinsic value of share = DPS1/(RR-g)
=0.7168/25.9%-12%)
=0.7168/13.9% = $5.16
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