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Suppose the risk-free rate is 2.78% and an analyst assumes a market risk premium of 6.68%....

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Finance

Suppose the risk-free rate is 2.78% and an analyst assumes amarket risk premium of 6.68%. Firm A just paid a dividend of $1.24per share. The analyst estimates the ? of Firm A to be 1.49 andestimates the dividend growth rate to be 4.71% forever. Firm A has272.00 million shares outstanding. Firm B just paid a dividend of$1.74 per share. The analyst estimates the ? of Firm B to be 0.89and believes that dividends will grow at 2.56% forever. Firm B has197.00 million shares outstanding. What is the value of Firm B?

Answer & Explanation Solved by verified expert
4.2 Ratings (517 Votes)

Step-1:Valuation of each share of firm
As per dividend discount model,
Current value of share = D0*(1+g)/(K-g) Where,
= 1.74*(1+0.0256)/(0.0873-0.0256) D0 Last paid dividend $       1.74
= $       28.92 g Growth rate 2.56%
K Cost of equity 8.73%
Working:
As per capital asset pricing method,
Cost of equity = Risk free rate + ? *market risk premium
= 2.78%+0.89*6.68%
= 8.73%
Step-2:Valuation of firm B
Value of firm B = Number of shares * Value per share
=         197.00 million * $    28.92
= $ 5,697.81 million

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Transcribed Image Text

Suppose the risk-free rate is 2.78% and an analyst assumes amarket risk premium of 6.68%. Firm A just paid a dividend of $1.24per share. The analyst estimates the ? of Firm A to be 1.49 andestimates the dividend growth rate to be 4.71% forever. Firm A has272.00 million shares outstanding. Firm B just paid a dividend of$1.74 per share. The analyst estimates the ? of Firm B to be 0.89and believes that dividends will grow at 2.56% forever. Firm B has197.00 million shares outstanding. What is the value of Firm B?

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