You have been asked to assess the value per share of Secure Savings, a mature sa

Question

You have been asked to assess the value per share of Secure Savings, a mature savings and loan company. The company had earnings per share in the just-com- pleted financial year of $4 per share and paid dividends of $2.40 per share. The book value of equity at the beginning of the year was $40 per share. The beta for the stock is 0.90, the risk-free rate is 6%, and the market risk premium is 4%.

a. Assuming that the firm will continue to earn its current return on equity in perpetuity and maintain its current dividend payout ratio, estimate the value per share.
b. If the stock is trading at $40 a share, estimate the implied growth rate.

Explanation / Answer

Answer a.
The company recently paid dividend of 2.40 ie. D0=2.40
company will continue current return of equity in perpetuity maintaining current dividend payout ratio thus growth = 0
rf=6%, market risk premium=4% beta=0.9
Cost of equity ie r= rf + beta*(rf-rm)
=rf + beta*(market risk premium)
=0.06+0.9*(0.04)
=0.06+0.036
=0.096
=9.6%

estimated value of share using GGM
= D0*(1+g) / r-g
= 2.40*(1+0) / 0.096-0
= 2.40 / 0.096
= 25
Thus the estimated value per share is $25


Answer b.
The stock price given is 40, dividend given = 2.40 and r=9.6% as calculated above.
Using GGM
value of share = D0*(1+g) / r-g
40 = 2.40*(1+g) / 0.096-g
40 = 2.40g / 0.096-g
40*(0.096-g) = 2.40g
3.84 - 40g = 2.40g
3.84 = 2.40g+40g
3.84 = 42.4g
g = 3.84/42.4
g = 0.09057
g = 9.06%

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