Question

The risk-free rate of return is 8%, the expected rate of return on the market portfolio is 15%, and the stock of Xyrong Corporation has a beta coefficient of 1.2. Xyrong pays out 40% of its earnings in dividends, and the latest earnings announced were $10 per share. Dividends were just paid and are expected to be paid annually. You expect that Xyrong will earn an ROE of 20% per year on all reinvested earnings forever. (LO 13-2) a. What is the intrinsic value of a share of Xyrong stock

Answer 1

$101.82

Step-by-step explanation:

the intrinsic value of the stock can be determined by determining the value of the stock using the constant growth dividend model

according to the constant dividend growth model

price = d1 / (r - g)

d1 = next dividend to be paid

r = required return

g = growth rate

growth rate = retention rate x ROE

Retention rate = 1 - payout ratio = 1 - 0.4 = 0.6

0.6 x 20% = 12%

dividend = 0.4 x $10 = $4

the required return can be determined using the capital asset price model: Expected rate of return = risk free + beta x (market rate of return - risk free rate of return)

0.08 + 1.2(0.15 - 0.08) = 0.164 = 16.4%

Intrinsic value = 4 ( 1.12) / (0.164 - 0.12) = 4.48/0.044 = $101.82