What should the current share prices be? QUESTION 3:TF, AB, & HY are all equity

Question

What should the current share prices be?

QUESTION 3:TF, AB, & HY are all equity financed firms. They follow a 100%, 70% and 30% dividend payout policies respectively. TF expects before personal tax return of $5, AB of $4, and HY of $7 per year in perpetuity. TF’s share is selling for $40. It has beta of 1.2. AB is twice as risky as TF and HY is 80% as risky as AB. Market risk premium is 4%.What should the current share prices of AB and HY be? Assume the marginal personal tax rate on dividends is 28% and on capital gains 23%.

Explanation / Answer

Calculaton of risk free return:

TF:

P0= D1/Ke 40= 5*.72/Ke    thus, Ke = 9% risk free return= 9%-1.2*4=4.2%

ABs current price= 4*.72/13.8%=$20.87 (4.2+2.4*4=13.8%)

HYs current price= 7*.72/ 8.04%=$62.69 (4.2+.96*4=8.04%)

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