Question

Tropical Inc. has reported ROE of 0.07 and a dividend payout ratio of 0.6. Its expected earnings for the next year is $2.7 per share, and the market capitalization rate is 0.15. What is Tropical's intrinsic value for today (t0)? Assume sustainable growth rate and constant growth DDM.

Answer 1

The Intrinsic value today is $13.28

Step-by-step explanation:

Given ROE = 0.07, Payout ratio = 0.6, EPS = $2.7, market cap = 0.15

MV = ?

Formula = D1/r-g

First need to find Dividends that are expected to be paid out

From what is given we will use the payout ratio formula

PR = DPS/EPS

0.6 = DPS/2.7

DPS/D1 = 0.6*2.7=$1.62

Also need to find g

g = ROE *retention ratio

=0.07*(1-0.6)

=0.028/2.8%

The market cap is rate that is commonly used as the approximation of the discount rate to calculate the present value of cash flows from a security

So sustituting to the formula

MV = 1.62/0.15-0.028

=$13.28

Answer 2

Value per share today is $13.28

Step-by-step explanation:

The sustainable growth rate can be calculated using the following formula,

Sustainable growth rate (g) = ROE * (1 - DividendPayout Ratio)

Where,

• ROE is the return on equity
• (1- dividend payout ratio) also known as retention ratio

Thus, g = 0.07 * (1-0.6) = 0.028 or 2.8%

The formula for price or intrinsic value per share is,

P0 or V = D1 / r-g

The earnings per share is Net income per share. Out of this net income, 60% will be paid out as dividends so dividend per share expected for next year is 2.7 * 0.6 = 1.62

Thus, value per share will be,

V = 1.62 / (0.15 - 0.028) = $13.278 rounded off to 13.28