Question

ABC Corp has a 13.33% return on equity and reinvests (retains) 35% of its profits. What is the intrinsic value of the company's share of stock, to the nearest penny, if the required rate of return is 12.87% and the most recent annual dividend per share (D0) was $2.66? If your answer is, e.g., $45.365, record it as 45.37.

Answer 1

The intrinsic value of ABC Corp's share of stock is approximately $34.54, calculated using the dividend discount model with a retention ratio of 35%, a return on equity of 13.33%, a recent annual dividend of $2.66, and a required rate of return of 12.87%.

Step-by-step explanation:

To calculate the intrinsic value of ABC Corp's stock using the dividend discount model (DDM), we first need to estimate the dividend growth rate using the company's return on equity (ROE) and retention ratio (b). The growth rate (g) can be calculated by multiplying ROE by the retention ratio, or g = ROE × b. Once we have the growth rate, we can calculate the dividend for the next year (D1) by taking the most recent dividend (D0) and growing it by g, so D1 = D0 × (1 + g). Finally, the intrinsic value (P) of the stock can be estimated using the formula: P = D1 / (r - g), where r is the required rate of return.

Given: ROE = 13.33%, Retention Ratio (b) = 35%, D0 = $2.66, Required Rate of Return (r) = 12.87%
First, we calculate the growth rate (g): g = 13.33% × 35% = 4.6655%.
Next, calculate D1: D1 = $2.66 × (1 + 4.6655%) ≈ $2.79.
Finally, calculate intrinsic value (P): P = $2.79 / (12.87% - 4.6655%) ≈ $34.54.

The intrinsic value of ABC Corp's share of stock is approximately $34.54.