Analog Corp has an ROE of 12% and a beta of 1.5. It plans to maintain indefinite

Question

Analog Corp has an ROE of 12% and a beta of 1.5. It plans to maintain indefinitely its traditional plowback ratio of 0.6. This year's earnings were $2.50 per share. The annual dividend was just paid. The consensus estimate of the coming year's market return is 10%, and the T-Bills currently offer a 4% yield. Find the price at which Analog's stock should sell. Calculate the P/E ratio. Calculate the present value of growth opportunities. Suppose your information suggest that the company will be reducing its plowback to 0.4. Find the intrinsic value of the stock if the cutback takes effect immediately.

Explanation / Answer

expected return = risk-free rate + beta * (expected return on the market - risk-free rate)

= 4+1.5*(10-4) = 13%

sustainable growth rate = ROE*plowback ratio = 12*0.6 = 7.2%

Dividends = earnings*(1-plowback ratio) = 2.5*(1-.6) = 1

Price =

Price = recent dividend* ( 1 + growth rate )/( required rate of return - growth rate)

= 1 * (1 + .072)/(0.13 - 0.072) = 18.4827

b

P/E = 18.4827/2.5 = 7.3931

c

PVGO = Price - price with 0 growth = 18.4827 - 1/.13 = 10.79

d

sustainable growth rate = ROE*plowback ratio = 12*0.4 = 4.8%

Dividends = earnings*(1-plowback ratio) = 2.5*(1-.4) = 1.5

Price =

Price = recent dividend* ( 1 + growth rate )/( required rate of return - growth rate)

= 1.5 * (1 + .048)/(0.13 - 0.048) = 19.1707

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