The market consensus is that Analog Electronic Corporation has an ROE = 11% and
ID: 2723390 • Letter: T
Question
The market consensus is that Analog Electronic Corporation has an ROE = 11% and a beta of 2.25. It plans to maintain indefinitely its traditional plowback ratio of 2/5. This year's earnings were $4.7 per share. The annual dividend was just paid. The consensus estimate of the coming year's market return is 14%, and T- bills currently offer a 6% return. Find the price at which Analog stock should sell. (Do not round intermediate calculations. Round your answer to 2 decimal places.) Calculate the P/E ratio. (Do not round intermediate calculations. Round your answers to 2 decimal places.) Calculate the present value of growth opportunities. (Negative amount should be indicated by a minus sign. 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 reduce its plowback ratio to 3/5. Find the intrinsic value of the stock. (Do not round intermediate calculations. Round your answer to 2 decimal places.)Explanation / Answer
ROE = Growth Rate x Plowback Ratio
=> 11% = Growth Rate x (2/5)
=> Growth Rate = 11% / (2/5) = 0.044 or 4.40%
Dividend Paid this year = $4.7 x (1-Plowback Ratio)
=> $4.7 x 0.6 = $2.82
Cost of equity = 6% + 2.25*(14% - 6%) = 24% (As per CAPM)
Price of Stock = [Dividend Paid*(1+Growth Rate)] / (Cost of equity – Growth Rate)
=> ($2.28*1.044)/(0.24 – 0.044) = $12.15
P/E Ratio = $12.15/$4.7 = 2.585
PVGO = Current Price – (EPS/Cost of equity)
=> $12.15 - ($4.7/0.24) = -$7.43
Intrinsic Value of stock, if Plowback ratio is reduced:
ROE = Growth Rate x Plowback Ratio
=> 11% = Growth Rate x (3/5)
=> Growth Rate = 11% / (3/5) = 0.066 or 6.60%
Dividend Paid this year = $4.7 x (1-Plowback Ratio)
=> $4.7 x 0.4 = $1.88
Price of Stock = [Dividend Paid*(1+Growth Rate)] / (Cost of equity – Growth Rate)
=> ($1.88*1.066)/(0.24 – 0.066) = $11.52
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