Question 5. FINA Company is expected to pay $4 dividend per share at the end of

Question

Question 5. FINA Company is expected to pay $4 dividend per share at the end of this year. FINA’s beta is 1.2. Three months US Treasury bill yield is 2 %, and the return on the S&P 500 index is 12 %. FINA Company is expected to growth at 6% per year forever. (total 6 points)

a. How much should be the value of FINA’s shares? (2 points)

b. If FINA shares are selling for $45 in the market, would you buy it? (1 point)

c. Now answer question with new numbers. Here we are given the following (3 points):

FINA Company paid $4 dividend per share last year. The cost of capital for FINA is 10 % and the company is expected to growth at 6% per year forever. How much should be the value of FINA’s shares?

If FINA shares are selling for $110 in the market, is it over-valued or under-valued? Should you buy                       it?

Explanation / Answer

Calculation of Cost of Capital:

Cost of Capital according to CAPM = RF + Beta (RM- RF)

RF = Risk Free Return = 2%, Beta = 1.2, RM = Market Return = 12%

Cost of Capital = 0.02 + 1.2 (0.12 - 0.02) = 14%

Value of Share = D1 / c - g

D1 = Dividend next year = 4, c = Cost of Capital = 14%, g = Growth Rate = 6%

Value of Share = 4 / 0.14 - 0.06 = $50

b. Yes if the price of the share is $45 it means it is undervalued and it is advisable to buy it because the true worth of the share is $50.

c. D1 = 4 x 1.06 = $4.24

Value of Share = 4.24 / 0.10 - 0.06 = $106

If the shares are selling at $110 in the market then it is overvalued. Then it is not advisable to buy it because the true worth of the share is only $106.

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