You are interested in purchasing the common stock of Azue Berhad. The firm recen

Question

You are interested in purchasing the common stock of Azue Berhad. The firm recently paid a dividend of RM3 per share. It expects its earnings, and hence its dividends, to grow at a rate of 7% for the foreseeable future. Currently, similar-risk stocks have required returns of 10%.
1. Given the data above, calculate the present value of this security. Use the constant-growth model to find the stock value.
2. One year later, your broker offers to sell you additional shares of Azue Berhad at RM73. The most recent dividend paid was RM3.21, and the expected growth rate for earnings remains at 7%. If you determine that the appropriate risk premium is 6.74% and you observe that the risk-free rate is currently 5.25%, what is the firm’s current required return?
3. Applying the constant-growth model, determine the value of the stock using the new dividend and required return from part b. Given your calculation in part c, would you buy the additional shares from your broker at RM73 per share? Explain.
4. Given your calculation in part c, would you sell your old shares for RM73? Explain. You are interested in purchasing the common stock of Azue Berhad. The firm recently paid a dividend of RM3 per share. It expects its earnings, and hence its dividends, to grow at a rate of 7% for the foreseeable future. Currently, similar-risk stocks have required returns of 10%.
1. Given the data above, calculate the present value of this security. Use the constant-growth model to find the stock value.
2. One year later, your broker offers to sell you additional shares of Azue Berhad at RM73. The most recent dividend paid was RM3.21, and the expected growth rate for earnings remains at 7%. If you determine that the appropriate risk premium is 6.74% and you observe that the risk-free rate is currently 5.25%, what is the firm’s current required return?
3. Applying the constant-growth model, determine the value of the stock using the new dividend and required return from part b. Given your calculation in part c, would you buy the additional shares from your broker at RM73 per share? Explain.
4. Given your calculation in part c, would you sell your old shares for RM73? Explain. You are interested in purchasing the common stock of Azue Berhad. The firm recently paid a dividend of RM3 per share. It expects its earnings, and hence its dividends, to grow at a rate of 7% for the foreseeable future. Currently, similar-risk stocks have required returns of 10%.
1. Given the data above, calculate the present value of this security. Use the constant-growth model to find the stock value.
2. One year later, your broker offers to sell you additional shares of Azue Berhad at RM73. The most recent dividend paid was RM3.21, and the expected growth rate for earnings remains at 7%. If you determine that the appropriate risk premium is 6.74% and you observe that the risk-free rate is currently 5.25%, what is the firm’s current required return?
3. Applying the constant-growth model, determine the value of the stock using the new dividend and required return from part b. Given your calculation in part c, would you buy the additional shares from your broker at RM73 per share? Explain.
4. Given your calculation in part c, would you sell your old shares for RM73? Explain.

Explanation / Answer

1) Stock value = D1/(Ke - g), where 'D1' is the next expected dividend, 'P0' is the current stock price and 'Ke' is the cost of equity (required rate on equity)

3*1.07/(0.10 - 0.07) = RM107

2)

As per the observation, the current required return = 6.74+5.25 = 11.99%.

3) Price of the stock = 3.21*1.07/(0.1199 - 0.07) = RM68.83

The additional shares would not be bought at RM73, as the value of the share is only RM68.83

4) Yes, I would sell the old shares as they are overpriced.

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