The market consensus is that Analog Electronic Corporation has an ROE = 6% and a
ID: 2758435 • Letter: T
Question
The market consensus is that Analog Electronic Corporation has an ROE = 6% and a beta of 1.30. It plans to maintain indefinitely its traditional plowback ratio of 1/3. This year's earnings were $3.0 per share. The annual dividend was just paid. The consensus estimate of the coming year's market return is 15%, and T-bills currently offer a 5% return. a. Find the price at which Analog stock should sell. b. Calculate the P/E ratio. c. Calculate the present value of growth opportunities. d. Suppose your research convinces you Analog will announce momentarily that it will immediately reduce its plowback ratio to 2/3. Find the intrinsic value of the stock.Explanation / Answer
Answer a
CAPM => Rf + (Rm - Rf) *Beta
=> 5% ( 15%-5%) *1.30 => 18%
Growth => 6%*1/3 => 2%
D1=> E0(1 + g) (1 – b)
=> 3(1.02)(2/3)
D1 => 2.04
Price => D1 (Ke - G)
=> 2.04 / (18% -2%)
Price => $12.75
Answer b
Leading => Price / E1
=> 12.75 / 3.06 (3+2%)
Leading => 4.17
Trailing => Price / E0
=> 12.75 / 3
Trailing => 4.25
Answer c
PVGO => Price - (E1 / Ke)
=> 12.75 - (3.06 / 18%)
PVGO => -$4.25
Answer d
Now revises to 2/3
So Growth => 6% * 2/3 => 4%
D1=> E0(1 + g) (1 – b)
=> 3(1.04)(1/3)
D1 => 1.04
So value => 1.04 / (18%-4%)
Intrinsic value of Stock => $7.43
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