Question

The market consensus is that Analog Electronic Corporation has an ROE = 9%, has a beta of 1.30, and plans to maintain indefinitely its traditional plowback ratio of 1/3. This year's earnings were $2.90 per share. The annual dividend was just paid. The consensus estimate of the coming year's market return is 11%, and T-bills currently offer a 5% return.

Find the price at which Analog stock should sell.

Answer 1

Please see below.

Step-by-step explanation:

a.

K = rf+beta(rm - rf) = 5 + 1.3*(11-5) = 12.8%

g = ROE*b = 9*1/3 = 3%

D1 = E0*(1+g)*(1-b) = 2.9*(1.03)*2/3 = 1.99

P0 = D1/(k-g) = 1.99/(0.128-0.03) = 20.32

b.

P/E ratio = price per share/EPS

Earnings at time period 1 (E1) = EPS*(1+g) = 2.9*(1+0.03) = 2.987

Leading = P0/E1 = 20.32/2.987 = 6.8

Trailing = P0/E0 = 20.32/2.9 = 7.0068

C.

PVGO = P0 - (E1/K) = 20.32 - (2.987/0.128) = -3.016

The low P/E ratios and negative PVGO are due to a poor ROE = 9%, which is less than the required rate = 12.8%