SUBJECT 1 B 4 years ago, Company A., paid dividends equal to €0.3858 per share. Today, the...

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SUBJECT 1 B
4 years ago, Company A., paid dividends equal to €0.3858 pershare. Today, the company paid dividends €0.80 per share (thusg1=20%). It plans to keep this growth rate steady for the next 3years and then the company’s dividend growth rate (g2) is expectedto be 8% flat for the foreseeable future. Considering thatinvestors require a return of 12% to invest in the company’sstocks, you are required to answer the following questions:
a. What is the intrinsic value per share ofCompany A. if you choose to use the Dividend Discount Model?
Is this Solution right? D1 = D0 * (1+g1)1= 0,8 * (1+0.20)^1 =0,96 / D2 = 0,8 * (1+0.20)^2 ? 1,15 and D3 = 0,8 * (1+0.20)^3 ?1,38
Present value of future dividends’ market price for a requiredrate of return =12%: 1st yr: D01 = 0,96/(1+0,12)^1? 0,8571 / 2nd yr: D02 =1,15/(1+0,12)^2 ? 0,9168 /3rd yr: D03 =1,38 /(1+0,12)^3 ? 0,9823. thusPresent value of the first 3 years of dividends = (0,8571 + 0,9168+ 0,9823) = 2,7562 € and Expected Value_stock at beginning of 4thyr end of 3rd yr = D4/(k-g2) = [D3(1+g2)]/(k-g2) = [1,38 (1+0,08)] / (0,12-0,08) = 37,26 €, thus Present value of stock at4th yr = Expected Value at 4th yr / (1+k)^3 thus, the PV of stock =37,26/(1+0,12)^3=26,5215 €. Adding 26,522 value to the presentvalue of all dividends to be received during the first 3 years, theintrinsic value is: 2,7562+26,5215 = 29,2777 € b.
b. If market currently prices Company's A shareat €25, would you put your money in Company A?
Answer: Comparing Stock’s intrinsic value (29,27 €) with itssuggested current market price (25 €) one can say that this stockis under-valuated and will provide the investor with a profit of(29,27-25) 4,27 € / share and thus should be preferred as aninvestment.
Please contribute to the restsub-questions:
c. Company B is the main competitor of CompanyA. The stock of Company A has a beta coefficient of 1.2 and it paysout 40% of its earnings in dividends. The latest earnings announcedby Company B were €10 per share. Dividends were just paid and areexpected to be paid annually. Based on your analysis you expectCompany B to earn a ROE of 20% per year on all reinvested earningsforever. Assuming that the risk-free rate of return is 8% and thatthe expected rate of return on the market portfolio is 15%,calculate the intrinsic value per share of Company B.
d. If the market price of Company B’s share iscurrently €60 would you invest in Company B or not?
e. If you had to choose between the twocompetitors, would the share of Company A or the share of Company Bbe your favorite? Explain briefly.
f. If a security is underpriced, then what isthe relationship between its market capitalization rate and itsexpected rate of return? Discuss briefly.

Answer & Explanation Solved by verified expert

3.8 Ratings (705 Votes)

c Working 1 Calculation of cost of equity Cost of equity Ke Rf Beta Rm Rf Here Rf Risk free rate 8 or 008 Beta 12 Rm Rate of market return 15 or 015 Now Cost of equity Ke 008 12 015 008 Cost of equity Ke 008 0084 0164 or 164 Working 2 Calculation of See Answer

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SUBJECT 1 B4 years ago, Company A., paid dividends equal to €0.3858 pershare. Today, the company paid dividends €0.80 per share (thusg1=20%). It plans to keep this growth rate steady for the next 3years and then the company’s dividend growth rate (g2) is expectedto be 8% flat for the foreseeable future. Considering thatinvestors require a return of 12% to invest in the company’sstocks, you are required to answer the following questions:a. What is the intrinsic value per share ofCompany A. if you choose to use the Dividend Discount Model?Is this Solution right? D1 = D0 * (1+g1)1= 0,8 * (1+0.20)^1 =0,96 / D2 = 0,8 * (1+0.20)^2 ? 1,15 and D3 = 0,8 * (1+0.20)^3 ?1,38Present value of future dividends’ market price for a requiredrate of return =12%: 1st yr: D01 = 0,96/(1+0,12)^1? 0,8571 / 2nd yr: D02 =1,15/(1+0,12)^2 ? 0,9168 /3rd yr: D03 =1,38 /(1+0,12)^3 ? 0,9823. thusPresent value of the first 3 years of dividends = (0,8571 + 0,9168+ 0,9823) = 2,7562 € and Expected Value_stock at beginning of 4thyr end of 3rd yr = D4/(k-g2) = [D3*(1+g2)]/(k-g2) = [1,38 *(1+0,08)] / (0,12-0,08) = 37,26 €, thus Present value of stock at4th yr = Expected Value at 4th yr / (1+k)^3 thus, the PV of stock =37,26/(1+0,12)^3=26,5215 €. Adding 26,522 value to the presentvalue of all dividends to be received during the first 3 years, theintrinsic value is: 2,7562+26,5215 = 29,2777 € b.b. If market currently prices Company's A shareat €25, would you put your money in Company A?Answer: Comparing Stock’s intrinsic value (29,27 €) with itssuggested current market price (25 €) one can say that this stockis under-valuated and will provide the investor with a profit of(29,27-25) 4,27 € / share and thus should be preferred as aninvestment.Please contribute to the restsub-questions:c. Company B is the main competitor of CompanyA. The stock of Company A has a beta coefficient of 1.2 and it paysout 40% of its earnings in dividends. The latest earnings announcedby Company B were €10 per share. Dividends were just paid and areexpected to be paid annually. Based on your analysis you expectCompany B to earn a ROE of 20% per year on all reinvested earningsforever. Assuming that the risk-free rate of return is 8% and thatthe expected rate of return on the market portfolio is 15%,calculate the intrinsic value per share of Company B.d. If the market price of Company B’s share iscurrently €60 would you invest in Company B or not?e. If you had to choose between the twocompetitors, would the share of Company A or the share of Company Bbe your favorite? Explain briefly.f. If a security is underpriced, then what isthe relationship between its market capitalization rate and itsexpected rate of return? Discuss briefly.