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Estimate the expected returns

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A magazine gave the following estimates for a firm:

Beta= 1.15

Dividend per share at date zero= $3.10

Expected Dividend per share in three years from zero= $4.10

Retention rate in three years from zero= 60%

ROE in three years from zero= 15%

The stock was selling for $49. Estimate the expected returns from purchasing at $49 and receiving the dividend stream projected by the magazine.

Also, the risk-free rate was 11.5%. Using a market risk premium of 6%, what can I conclude about the purchase of the company's shares?

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Solution Preview

Please refer to the attachment.

The required rate of return is k = Rf+ Beta*Rm=11.5+1.15*6= 18.4%
The growth ratio is g = Retention rate * ROE = 60%*15% =9% in 3 years
Since we don't know how much can we sell the bond 3 years ...

Solution Summary

The expert estimates the expected returns.