present value of growth opportunities
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1. The market consensus is that Analog Electronic Corporation has an ROE = 12%, a beta of 1.25, and it plans to maintain indefinitely its traditional plowback ratio of 2/3. This year's earnings were $3 per share. The annual dividend was just paid. The consensus estimate of the coming year's market return is 14% and T-bills currently offer a 6% return.
a. Find the price at which Analog stock should sell.
b. Calculate the P/E ratio (Note: you should compute the ratio of the price to next year's earnings)
c. Calculate the present value of growth opportunities.
d. Suppose your research convinces you that Analog will announce momentarily that it will immediately increase its dividend policy to 2/3rds of future earnings. Find the new intrinsic value of the stock. The market is still unaware of this decision. Should you buy or sell Analog stock. Why?
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The present value of growth opportunities are calculated.
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1. The market consensus is that Analog Electronic Corporation has an ROE = 12%, a beta of 1.25, and it plans to maintain indefinitely its traditional plowback ratio of 2/3. This year's earnings were $3 per share. The annual dividend was just paid. The consensus estimate of the coming year's market return is 14% and T-bills currently offer a 6% return.
a. Find the price at which Analog stock should sell.
The plowback ratio measures the amount of earnings retained after dividends have been paid out. (also known as "retention rate")
Then the firm's growth rate = ROE * plowback ratio = 12% * 2/3 = 8%
Its dividend payout ratio = 1- plowback ratio = 1/3
This year's dividend is then D = $3 * 1/3 = $1
The market return Rm = 14%,
and risk free ...
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