(TCO D) Find the intrinsic value of the stock of company ABC using the following

Question

(TCO D) Find the intrinsic value of the stock of company ABC using the following data:
risk free rate = 5%
market risk premium = 8%
Expected market return = risk free rate + market risk premium
beta = 0.9
ROE = 12.5%
dividend payout ratio = 0.22
Dividends for the next 4 years are expected to be .59, .67, .76, .85. Subsequent growth will be at the computed growth rate, g.

Suggestion:
1. Find g from ROE and payout ratio
2. Find k from CAPM
3. Find price of ABC 4 years out using the constant growth DDM
4. Find intrinsic value by discounting each annual dividend by (1+k)^n where n=number of years, summing them and adding the price in step 3 discounted by (1+k)^4

Explanation / Answer

retention rate = 1-payout ratio = 0.78

g = 0.78*ROE = 9.75%

k = 5 + 0.9*(8-5) = 7.7%

Price of ABC 4yrs= D5/ROE-g = .85*1.0975/(.125-.0975) = 33.92

Intrinsic value = .59/(1+.077) + .67/(1+.077)^2 + .76/(1+.077)^3 + .85/(1+.077)^4 + 33.92/(1+0.77)^4 = 2.37 + 25.21 = 27.58

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