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The risk-free rate of return is 6%, the expected rate of return on the market portfolio is 15%, and the stock of Xyrong Corporation has a beta coefficient of 2.3. Xyrong pays out 45% of its earnings in dividends, and the latest earnings announced were $9.00 per share. Dividends were just paid and are expected to be paid annually. You expect that Xyrong will earn an ROE of 18% 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.)

b. If the market price of a share is currently $22, and you expect the market price to be equal to the intrinsic value one year from now, what is your expected 1-year holding-period return on Xyrong stock? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Respuesta :

Answer:

(i) $26.49375

(ii) $29.11

(iii) 52.54%

Explanation:

Required rate of return using CAPM model:

= risk free rate + beta (expected return - risk free rate)

= 0.06 + 2.3 (0.15 - 0.06)

= 0.267 or 26.7%

Growth rate = (1 - dividend payout ratio) × ROE

                    = (1 - 0.45) × 0.18

                    = 0.099 or 9.9%

a)

Dividends per share will be $4.05 since payout ratio is 45%

Intrinsic value of share = D1 ÷ (Rate - growth)

                                      = 4.05(1.099) ÷ (0.267 - 0.099)

                                      = 4.45095 ÷ 0.168

                                      = $26.49375

b)

Price after 1 year = 26.49( 1 + 0.099)

Price after 1 year = $29.11

c)

One year holding period return = ( $29.11 + 4.45 - 22) ÷ 22

                                                     = 0.5254 or 52.54%

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