You expect Seton Venture to have a ROE of 18%, a beta of 1.25, an expected earni

Question

You expect Seton Venture to have a ROE of 18%, a beta of 1.25, an expected earnings per share (E1) of $4.73, and a stable retention ratio (b) of 70%. The expected market return for future years is 12%, and the 10-year Treasury note is yielding 1.8%.

a) Calculate the intrinsic value estimate of Seton Venture stock (V0) according to the constant growth DDM.

b) Calculate the Present Value of Growth Opportunities (PVGO).

c) Calculate the justifiable forward P/E and trailing P/E according to the constant growth DDM.

d) If the expected ROE for Seton Venture has been revised down to 14% from 18%, recalculate the V0, PVGO, and the justifiable forward P/E and trailing P/E. Discuss whether these changes in V0, PVGO, and the justifiable forward P/E and trailing P/E are consistent with the concepts that we learned from class.

Explanation / Answer

growth= ROE*retention ratio

=18%*70%=12.6%

dividend=4.73*0.3=$1.42

value= expected dividend/(k-g) where k= cost of capital g=growth rate

k=Rf+beta*(Rm-Rf)

=1.8%+1.25*(12%-1.8%)=14.55%

=2.42/(14.55%-12.6%)=$72.82

b)PVGO = Price0 – (Earnings current period / rce)

Price0=4.73/14.55%=$32.51

PVGO=72.82-32.51=40.31

c)trailing P/E= 72.82/4.73=15.4

justifibale forward P/E=40.32/4.73=8.52

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