The market consensus is that Analog Electronic Corporation has an ROE-10% and a
ID: 2613813 • Letter: T
Question
The market consensus is that Analog Electronic Corporation has an ROE-10% and a beta of 1 50 it plans to mainta indefinitely its traditional plowback ratio of 4/5. This year's earnings were $2.1 per share. The annual dividend was just paid. The consensus estimate of the coming years market return is 15%, and T-bills currently offer a 5% return a. Find the price at which Analog stock should sell.(Do not round intermediate calculations. Round your answer to 2 decimal places.) Pice $ b. Calculate the P/E ratio (Do not round intermediate calculations. Round your answers to 2 decimal places PIE ratio Leading Trailing c. Calculate the present value of growth opportunities (Negative amount should be indicated by a minus sign. Do not round intermediate caiculations. Round your answer to 2 decimal places d. Suppose your research convinces you Analog will announce momentanily that it will immediately reduce its plowback ratio to 1/5.Find the intrinsic value of the stock. (Do not round intermediate calculations. Round your answer to 2 decimal piaces.) S Intrinsic value of the stock
Explanation / Answer
Solution:-
a) Ans:- $3.78
b) Ans:-Leading PE= 1.67
Trailing PE= 1.80
c)Ans:- -$7.56 ( Note it is negative)
d)Ans:- $9.52
Workings:-
a) Calculation of price of share
First calculate cost of equity using CAPM model (Ke)= Rf+Beta*(Rm-Rf)
= 5%+1.50*(15%-5%)= 20.00%
Growth rate (g)= ROE*retention ratio = 10%*4/5=8%
Last dividend paid( DPS0)=$2.10*1/5=$0.42
Using DDM , Price of the share
( P0) =DPS0*(1+g)()Ke-g)
= $0.42*1.08/(20%-8%)
=$0.4536/12%= $3.78
b) Calculation of PE ratio
Leading PE ratio = P0/EPS1
=3.78/(2.1*1.08) =3.78/2.268= 1.67
Trailing PE ratio =P0/EPS0= 3.78/2.10=1.80
c) Present value of growth opportunities =
Price of share taking growth- Price without growth
=3.78(calculated above)-EPS1/RR
=3.78-2.1*1.08/20% = 3.78-11.34= -$7.56
d) If the retention ratio is changed to 1/5
Growth rate = ROE*Retention ratio= 10%*1/5= 2%
DPS0 will be = $2.10*4/5=$1.68
DPS1= DPS0*(1+2%%)=1.68*1.02=1.7136
Intrinsic value of share = DPS1/(RR-g)
=1.7136/20%-2%)
=1.7136/18% = $9.52
Please feel free to ask if you have any query in the comment section.
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