Question

StoreAge Inc. recently paid its annual dividend of $1, and reported an ROE of 15%. The firm pays out 50% of its earnings as dividends. The stock has a beta of 1.0. The current risk-free rate is 2.1% and the market return is 11.1%. Assuming that CAPM holds, what is the intrinsic value of this stock?

Answer 1

$29.86

Step-by-step explanation:

The computation of the intrinsic value is shown below:-

Growth rate of Dividends= Return on equity × Dividend paid percentage

= 15% × 50%

= 7.5%

Required return = Risk free rate + Beta × Market risk premium

= 2.1% + 1.0 × Market risk premium

Market risk premium = Market return - Risk free rate

= 11.1% - 2.1%

= 9%

So,

Required return= 2.1% + 1.0 × 9%

= 2.1% + 9%

= 11.1%

Intrinsic value of stock = D1 ÷ (Required return - Growth rate)

So, D1 = $1 × (1 +7.5%)

= $1.075

= $1.075 ÷ (11.1% - 7.5%)

= $1.075 ÷ 3.6%

= $29.86