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

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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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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?