Catalina Bank (CB) currently pays a dividend of $2.75 per share. T-bills are pay
ID: 2725653 • Letter: C
Question
Catalina Bank (CB) currently pays a dividend of $2.75 per share. T-bills are paying a 1.45% return and the market is anticipated to earn 9.65% per year. AAS has a beta of 1.32 and retains 60% of their earnings every year. CB earnings and dividends are expected to grow 10.6% per year for the next three years, then 8.6% for the following two years, before settling at constant 6.2% growth forever after.
a. What is the cost of equity (market capitalization rate) for CB?
b. What is the value of CB shares today?
c. If CB shares are selling for that value, what is PVGO per share for the company?
Please show your work as well as the answer!
Explanation / Answer
Part a)
Cost of equity = Rf +(Rm – Rf) x beta
= 1.45% + (9.65% -1.45%) x 1.32
= 12.274%
Part b)
year
growth rate
Dividend
0
2.75
1
10.60%
3.04
2
10.60%
3.36
3
10.60%
3.72
4
8.60%
4.04
5
8.60%
4.39
Price at the end of year 5:
P5 = D5 x (1+g)/ (R-g)
= 4.39 x (1+0.062)/(0.12274-0.062)
= 76.76
Price today would be the present value of future dividends and prices.
Year
Cash flow
PV factor 12.274%
PV
1
3.04
0.8907
2.71
2
3.36
0.7933
2.67
3
3.72
0.7066
2.63
4
4.04
0.6293
2.54
5
4.39
0.5605
2.46
5
76.76
0.5605
43.03
56.04
Current price = 56.04.
Part c)
EPS = 2.75/(1-0.60) = 6.875
PVGO = Price – EPS/ Ke
= 56.04 -6.875/ 0.12274
= 0.0273
year
growth rate
Dividend
0
2.75
1
10.60%
3.04
2
10.60%
3.36
3
10.60%
3.72
4
8.60%
4.04
5
8.60%
4.39
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