You are asked to provide the valuation for two stocks: i) Assume that the risk-free rate of interest is 5% and the expec
Posted: Thu Apr 28, 2022 1:58 pm
You are asked to provide the valuation for two stocks:
i) Assume that the risk-free rate of interest is 5% and the
expected rate of return on the market is 15%. Stock
A is currently selling at $40 per share. The stock is
expected to pay $5 dividends next year, and you expect it to sell
then for $50 per share. The stock has a beta of 1.25. Is
Stock A currently underpriced or overpriced?
(4 Marks)
ii) Assume that the risk-free rate of interest is 5% and the
expected rate of return on the market is 15%. The Company of
Stock B pays no cash dividend currently and is not
expected to for the next 10 years. Its latest EPS (Earnings Per
Share) was $5, all of which was reinvested in the company. The
firm’s expected ROE for the next 10 years is 25% per year. And
during this time it is expected to continue to reinvest all of its
earnings. The beta of Stock B is 1.0. You have two scenarios:
ii.a) If starting in year 11, the firm’s ROE on new investment
is expected to fall to 20%, and the company is expected to start
paying out 50% of its earnings in cash dividends, which it will
continue to do forever after. Given the current situation, what is
the intrinsic value of Stock B? (8 Marks)
ii.b) Alternatively, if starting in year 11,
Stock B’s ROE falls into 20% and the company is expected to start
paying out 30% of its earnings in cash dividends, which it will
continue to do forever after, what is its intrinsic value under the
new payout policy? Given your calculation, explain why lower payout
policy benefits or hurts Stock B’s valuation? (8
Marks)
i) Assume that the risk-free rate of interest is 5% and the
expected rate of return on the market is 15%. Stock
A is currently selling at $40 per share. The stock is
expected to pay $5 dividends next year, and you expect it to sell
then for $50 per share. The stock has a beta of 1.25. Is
Stock A currently underpriced or overpriced?
(4 Marks)
ii) Assume that the risk-free rate of interest is 5% and the
expected rate of return on the market is 15%. The Company of
Stock B pays no cash dividend currently and is not
expected to for the next 10 years. Its latest EPS (Earnings Per
Share) was $5, all of which was reinvested in the company. The
firm’s expected ROE for the next 10 years is 25% per year. And
during this time it is expected to continue to reinvest all of its
earnings. The beta of Stock B is 1.0. You have two scenarios:
ii.a) If starting in year 11, the firm’s ROE on new investment
is expected to fall to 20%, and the company is expected to start
paying out 50% of its earnings in cash dividends, which it will
continue to do forever after. Given the current situation, what is
the intrinsic value of Stock B? (8 Marks)
ii.b) Alternatively, if starting in year 11,
Stock B’s ROE falls into 20% and the company is expected to start
paying out 30% of its earnings in cash dividends, which it will
continue to do forever after, what is its intrinsic value under the
new payout policy? Given your calculation, explain why lower payout
policy benefits or hurts Stock B’s valuation? (8
Marks)