The market consensus is that Analog Electronic Corporation has an ROE = 11% and

Question

The market consensus is that Analog Electronic Corporation has an ROE = 11% and a beta of 2.00. It plans to maintain indefinitely its traditional plowback ratio of 3/5. This year's earnings were $2.4 per share. The annual dividend was just paid. The consensus estimate of the coming year's market return is 16%, and T-bills currently offer a 5% return.

Find the price at which Analog stock should sell. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Suppose your research convinces you Analog will announce momentarily that it will immediately change its plowback ratio to 2/5. Find the intrinsic value of the stock. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

The market consensus is that Analog Electronic Corporation has an ROE = 11% and a beta of 2.00. It plans to maintain indefinitely its traditional plowback ratio of 3/5. This year's earnings were $2.4 per share. The annual dividend was just paid. The consensus estimate of the coming year's market return is 16%, and T-bills currently offer a 5% return.

Explanation / Answer

expected return = risk-free rate + beta * (expected return on the market - risk-free rate)

= 5 + 2 * (16 -5) = 27%

Dividend = EPS * (1 - plowback ratio) = 2.4 * (1 - 3/5) = 0.96

Growth rate = ROE + plowback ratio = 11*3/5 = 6.6%

Price = recent dividend* ( 1 + growth rate )/( required rate of return - growth rate)

= 0.96 * (1 + .066)/(0.27 - 0.066) = 5.02

b

Dividend = EPS * (1 - plowback ratio) = 2.4 * (1 - 2/5) = 1.44

Growth rate = ROE + plowback ratio = 11*2/5 = 4.4%

Price = recent dividend* ( 1 + growth rate )/( required rate of return - growth rate)

= 1.44* (1 + .044)/(0.27 - 0.044) = 6.65

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