Question

The market consensus is that Analog Electronics Corporation has an ROE = 15%, a beta of 1.90, and plans to maintain indefinitely its traditional plowback ratio of 1/5. This year’s earnings were $3.20 per share. The annual dividend was just paid. The consensus estimate of the coming year’s market return is 16%, and T-bills currently offer a 5% return.

a. Find the price at which Analog stock should sell. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Price - $11.51

b. Calculate the P/E ratio. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Leading --- ?

Trailing ---- 3.6

c. Calculate the present value of growth opportunities. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.)

PVGO -$1.21

d. Suppose your research convinces you Analog will announce momentarily that it will immediately change its plowback ratio to 4/5. Find the intrinsic value of the stock. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Intrinsic Value ??:

Answer 1

a)

Required return on Equity(r) = Risk free rate + Beta*(Market return-Risk free rate)

Return on T-bills is equivalent to risk free rate

Therefore, r = 5 + 1.9*(16-5)

r = 25.9%

Sustainable growth rate(g) = ROE*plow back ratio

= 15*1/5 = 3%

Dividend payout ratio = 1- plow back ratio = 1-1/5 =4/5

Dividend = Earnings per share*Dividend payout ratio

= 3.2*4/5

= 2.56

Stock Price = Dividend*(1+g)/(r-g)

= 2.56*(1+0.03)/(0.259-0.03)

= $11.51

b) Leading P/E ratio = P₀/E₁

E₀ = $3.2

E₁ = E₀*(1+g) = 3.2*(1+.03) = 3.29

Therefore, leading P/E ratio = 11.51/3.29 = 3.49

Trailing P/E ratio = P₀/E₀ = 11.51/3.2 = 3.6

c) P₀ = E₁/r + PVGO

PVGO = 11.51 - 3.29/0.259 = -$1.21

d) g= 15*4/5 = 12%

Dividend payout ratio = 1-4/5 = 1/5

Dividend = 3.2*1/5 = 0.64

Stock price = 0.64*(1+0.12)/(0.259-0.12)

= $5.16

Therefore intrinsic value of stock with the change in plowback ratio = $5.16