The board of directors of API, a relatively new electronics manufacturer, has de
ID: 2648994 • Letter: T
Question
The board of directors of API, a relatively new electronics manufacturer, has decided to beginning paying a common stock dividend to increase the attractiveness of the stock in the free market. The board plans to pay $3.00 per share in the coming year (i.e., next year) and anticipates that its future dividends will increase at an annual rate consistent with that experienced over the period from 2009 - 2012 (see below). The company currently has a beta of 1.1, the rate of return for the market is expected to be 10% and the risk-free rate is currently 4%. Given this scenario, what is the current value of API's common stock? If the current market price is $40.00 per share, should you purchase this stock. Briefly, explain your answer. (HINT: This problem requires a three-part calculation to solve it)
Year Dividend
2012 $2.81
2011 $2.70
2010 $2.60
2009 $2.50
Explanation / Answer
Rm= 10% Rf= 4% Beta= 1.1 Re= Rf+ (Rm-Rf)*Beta Hence, Re= 4 + (6*1.1)= 10.6% Year Dividends growth=(New-old)/old 2009 2.50 - 2010 2.60 0.04 2011 2.70 0.04 2012 2.81 0.04 Hence, growth= 4% Expected Dividend i.e. D1= 3 Growth= g= 4% Re= 10.6% Hence, Present Value= D1/(Re-g) Thus, Present Value= 3/(10.6%-4%)= 45.45 Hence, at market price of $40, one should buy the stock
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