The risk-free rate of return is 85%, the expected rate of return on the market p

Question

The risk-free rate of return is 85%, the expected rate of return on the market portfolio is 15%, and the stock of Xyrong Corporation has a beta coefficient of 2.9. Xyrong pays out 40% of its earnings in dividends, and the latest earnings announced were $25 per share. Dividends were just paid and are expected to be paid annually. You expect that Xyrong will earn an ROE of 22% per year on all reinvested earnings forever a. What is the intrinsic value of a share of Xyrong stock? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Intrinsic value s b-1. It the market price of a share is currently $79 and you expect the market price to be equal to the intrinsic value one year from now, calculate the price of the share ater one year from now (Do not round intermediate calculations. Round your answer to 2 decimal places.) Price b-2. What is your expected one-year holding peniod return on Xyrong stock? (Do not round intermediate caiculations. Round your answer to 2 decimal places.) - Expected one-year holding penod return %

Explanation / Answer

a. Risk-Free Rate = 8.5%

Expected rate of return on Market Portfolio = 15%

Beta = 2.9

As per the CAPM, model = Risk Free Rate + Beta* (Market Return – Risk Free Rate)

Or, Expected Return of the stock (%) = 8.5% + 2.9* (15%-8.5%) = 27.35%

Earnings per Share = $25

Dividend out @40% pa, so retention ratio is 60%

Dividend per Share is $25*40% = $10per share

Return on Equity is 22%

So Growth Rate = Return on Equity * Retention Ratio

Or, Growth Rate = 22%*60% = 13.2%

Intrinsic Value per share = Dividend Paid recently * (1 + growth rate) / expected return of stock – growth rate

Or, Intrinsic Value per share = $10* (1.132) / (0.2735-0.132) = $80

b. Value of the Share after one year from now would be: Intrinsic Value per share * (1 + growth rate)

Value of the share after one year from now = $80*(1.132) = $90.56

c. Expected Holding Return of the stock = (Dividend for the next year + Intrinsic Value of the share after 1 year – Value of the share now/ Value of the share now)* 100

Value of the share now = $79

Dividend for the next year = $25*40 %*( 1.132) = $11.32

Value of the share after one year from now = $90.56

Expected Holding Return of the stock = ($11.32 + $90.56 - $79/ $79)*100= 28.96%

So the expected holding return of the stock would be 28.96%

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