Stuck on #3 and #4 part of this problem:
ABC Company just paid a dividend of $3 per share out of $4 earnings available to common stockholders. The dividend is expected to grow at a rate of 20% per year for the next 3 years and then level off to negative 5% per year forever. The risk-free rate of return is 6%, the expected risk premium on the market portfolio is 6%, and the stock of ABC Company has a beta coefficient of 2.
1) Calculate the equilibrium required rate of return according to the CAPM
E(R)=6%+6%(2)=18%
2) Estimate the fair value of the stock:
3) Calculate the present value of growth opportunity
This is where I am having trouble, how do I account for the negative 5% growth rate?
No growth value = $4/.18 = $22.22
P0= $22.32 (from above)
PVGO = $22.32-$22.22 = $.10
4) If the stock is selling at $23, is the market in equilibrium? If not, how would equilibrium be achieved?
(How do I calculate the expected rate of return?)
No, the stock is overpriced, lying below SML. To achieve equlibrium, decrease demand to decrease the price from market price of $23 to fair value price of $22.32. The expected rate of return will increase from ??% to the required rate of return of 18%.
ABC Company just paid a dividend of $3 per share out of $4 earnings available to common stockholders. The dividend is expected to grow at a rate of 20% per year for the next 3 years and then level off to negative 5% per year forever. The risk-free rate of return is 6%, the expected risk premium on the market portfolio is 6%, and the stock of ABC Company has a beta coefficient of 2.
1) Calculate the equilibrium required rate of return according to the CAPM
E(R)=6%+6%(2)=18%
2) Estimate the fair value of the stock:
3) Calculate the present value of growth opportunity
This is where I am having trouble, how do I account for the negative 5% growth rate?
No growth value = $4/.18 = $22.22
P0= $22.32 (from above)
PVGO = $22.32-$22.22 = $.10
4) If the stock is selling at $23, is the market in equilibrium? If not, how would equilibrium be achieved?
(How do I calculate the expected rate of return?)
No, the stock is overpriced, lying below SML. To achieve equlibrium, decrease demand to decrease the price from market price of $23 to fair value price of $22.32. The expected rate of return will increase from ??% to the required rate of return of 18%.
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