The risk-free rate of return is 10.0%, the expected rate of return on the market

Question

The risk-free rate of return is 10.0%, the expected rate of return on the market portfolio is 20%, and the stock of Xyrong Corporation has a beta coefficient of 2.6. Xyrong pays out 60% of its earnings in dividends, and the latest earnings announced were $25 per share. Dividends were just paid and are expected to be paid annually. You expect that Xyrong will earn an ROE of 22% per year on all reinvested earnings forever.

a. What is the intrinsic value of a share of Xyrong stock? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Intrinsic value $ =

b-1. If the market price of a share is currently $59, and you expect the market price to be equal to the intrinsic value one year from now, calculate the price of the share after one year from now. (Do not round intermediate calculations. Round your answer to 2 decimal places.) Price $ =

b-2. What is your expected one-year holding-period return on Xyrong stock? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Expected one-year holding-period return % = 38.39

Explanation / Answer

a) Required rate of return as per CAPM = risk free rate+Beta*(return on the market portfolio-risk free rate) = 10+2.6*(20-10) = 36.00% Growth rate = ROE*Retention rate = 40%*22% = 8.80% Intrinsic value = D1/(r-g) where D1 = next expected dividend, r=required return and g=growth rate. Last dividend = 25*60% = $15 Intrinsic value = 15*1.088/(0.36-0.088) = $         60.00 b-1) Price of the share 1 year from now = D2/(0.36-0.088) = 15*1.088^2/(0.36-0.088) = $         65.28 b-2) Holding period return = (15*1.088+65.28-59)/59 = 38.31%

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