The risk-free rate of return is 7.0%, the expected rate of return on the market
ID: 2759305 • Letter: T
Question
The risk-free rate of return is 7.0%, the expected rate of return on the market portfolio is 15%, and the stock of Xyrong Corporation has a beta coefficient of 1.6. Xyrong pays out 30% of its earnings in dividends, and the latest earnings announced were $9.00 per share. Dividends were just paid and are expected to be paid annually. You expect that Xyrong will earn an ROE of 20% per year on all reinvested earnings forever.
a. What is the intrinsic value of a share of Xyrong stock? (Do not round intermediate calculations. Round your answer to 2 decimal places.
b. If the market price of a share is currently $50.00, and you expect the market price to be equal to the intrinsic value 1 year from now, what is your expected 1-year holding-period return on Xyrong stock? Do not round intermediate calculations. Round your answer to 2 decimal places.
Explanation / Answer
A)
k = rf+[E(rM) – rf] = 7% + 1.6(15% – 7%) = 19.8%
g = b*ROE = 0.7*20% = 14%
V0= D0(1+g) / k-g = $2.7(1.14) / (0.198 - 0.14) = $53.06
B)
P1= V1= V0(1 + g) = $53.06 * 1.14 = $60.48
E(r) = ( D1 + P1 - P0 ) / P0 = ( $3.078+ $60.48 - $50 ) / $50 = 0.2711 or 27.11%
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