Charles Freeman, portfolio manager for Windsor Fund, was considering the purchase of CISCO’s common stock. Freeman...

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Charles Freeman, portfolio manager for Windsor Fund, wasconsidering the purchase of CISCO’s common stock. Freeman believedthat CISCO’s earnings can grow at 20 percent per year over the nextfive years after which the CISCO’s earnings multiple will fall to amarket multiple. Freeman thinks that the risk involved in CISCO’sshares is greater than that for the general market during itshigh-growth phase and, therefore, the appropriate discount rate tobe applied to CISCO’s shares should be 3 percentage points greaterthan the long-run return from the market over the next fiveyears.
Using the growth-stock valuationmodel, answer the following two questions
What is the proper value of CISCO?
Hint: It is possible to obtain thedividend yield of the S&P by dividing payout of the S&P byits P/E.
What growth rate is implied by CISCO’s current price?
Additional information at the time ofdecision:
CISCO’s earnings per share (currentyear)                     $.70
CISCO’s dividend payoutratio                                           0
CISCO’s marketprice                                                  21.00
P/E for S&P 500 (next year’s earnings)                            20
                                                                  (youcan use this for M_S&P)
Assume the dividend payout for S&P500                    30%
Anticipated long-run growth rate for earnings and dividendsS&P500                                   6½%
                                              g                        (1+g)⁵
                                             .10                         1.61
                                             .11                         1.69
                                             .12                         1.76
                                             .13                         1.84
                                             .14                         1.93
                                             .15                         2.01
                                             .20                         2.49
                                             .25                         3.05
                                             .30                         3.71
                                             .36                         4.65
                                             .40                         6.19
                                             .50                         9.13

Answer & Explanation Solved by verified expert

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A what is the proper value of Cisco Sol by the hint given in the question we can easily calculate the growth rate of SP as 15 and add 3 premium for calculating the growth rate of See Answer

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Transcribed Image Text

Charles Freeman, portfolio manager for Windsor Fund, wasconsidering the purchase of CISCO’s common stock. Freeman believedthat CISCO’s earnings can grow at 20 percent per year over the nextfive years after which the CISCO’s earnings multiple will fall to amarket multiple. Freeman thinks that the risk involved in CISCO’sshares is greater than that for the general market during itshigh-growth phase and, therefore, the appropriate discount rate tobe applied to CISCO’s shares should be 3 percentage points greaterthan the long-run return from the market over the next fiveyears.Using the growth-stock valuationmodel, answer the following two questionsWhat is the proper value of CISCO?Hint: It is possible to obtain thedividend yield of the S&P by dividing payout of the S&P byits P/E.What growth rate is implied by CISCO’s current price?Additional information at the time ofdecision:CISCO’s earnings per share (currentyear) $.70CISCO’s dividend payoutratio 0CISCO’s marketprice 21.00P/E for S&P 500 (next year’s earnings) 20 (youcan use this for MS&P)Assume the dividend payout for S&P500 30%Anticipated long-run growth rate for earnings and dividendsS&P500 6½% g (1+g)5 .10 1.61 .11 1.69 .12 1.76 .13 1.84 .14 1.93 .15 2.01 .20 2.49 .25 3.05 .30 3.71 .36 4.65 .40 6.19 .50 9.13