Adled Electronics stock currently sells for $10 per share, and the company has 1

Question

Adled Electronics stock currently sells for $10 per share, and the company has 1,000,000 shares of stock outstanding. The company just paid a dividend of $1.00 per share, and reported earnings of $10,000,000. The company’s current return on equity is 14%, and this rate is expected to persist into the foreseeable future. a) What is the required return for Adled Electronics stock? b) At what price should the stock sell three years from today (just after the time 3 dividend)? c) At what price should the stock sell three years from today (just before the time 3 dividend)?

Explanation / Answer

growth rate=ROE*(1-payout ratio

ROE=14%

payout ratio=1,000,000,/10,000,000=10%

g=14%*(1-10%)=12.6%

price=dividend*(1+g)/(k-g)

10=1*(1+12.6%)/(k-12.6%)

k=23.86% which is reuqired rate of return

b)PV of the stock

=[1*1.126^1/(1+23.86%)^1]+ [(1*1.126^2)/(1+23.85%)^2]+[(1*1.126^3)/(1+23.85%)^3]

terminal value=(1.126^4)/(23.86%-12.6%)=12.758

pv of termianl value=12.758/(1+23.85%)^3=6.71

=$9.2

c)[1*1.126^1/(1+23.86%)^1]+ [(1*1.126^2)/(1+23.85%)^2

terminal value=(1.126^3/(23.86%-12.6%)=11.33

pv of termianl value=11.33/(1+23.85%)^2=7.39

=9.12

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