(a) Beta = 2.4, Risk-Free Rate = T-Bill = 8 % and Market Return = S&P Rate = 18%
Cost of Equity = 8 + 2.4 x (18-8) = 32 %
Return on Equity = 20%, Dividend Payout Ratio = 50 %
Retention Ratio = 100 - Dividend Payout Ratio = 100 - 50 = 50 %
Constant Perpetual Growth Rate Generated = Return on Equity x Retention Ratio = 20 x 0.5 = 10 %
Latest EPS =E0 = $ 20, Current Dividend = D0 = E0 x 0.5 = 20 x 0.5 = $ 10
Current Intrinsic Price = (10 x 1.1) / (0.32-0.1) = $ 50
(b1) As the provided combination of return on equity and retention ratio generates a constant perpetual growth rate of 10%, everything else remaining same, the earnings dividends and stock price will also rise by 10% each year (perpetual constant growth generated)
Hence, Stock Price after 1 Year = 50 x 1.1 = $ 55
(b2) Return Generated in 1 Year: Dividend Received at the end of 1 Year + Increase in Stock Price
Therefore, Initial Value = $ 50, Final Value = Dividend + Final Stock Price = 11 + 55 = $ 66
Holding Period Return = [(66-50) / 50] x 100 = 26 %
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