Question

The market consensus is that Samsung Electronics has an ROE of 9% , and a beta of 1.25. It plans to maintain indefinitely its traditional plowback ratio of 2/3. This year's earnings were $3/share. The annual dividend was just paid. The consensus estimate of the coming year's market return is 14%, and T-bills currently offer 6 % return. a. (4pts) Find the price at which Samsung Stock should sell 4. b. (3pts) Calculate the P/E ratio (3pts) Calculate the PV of growth opportunities. c.

d. Suppose your research convinces you Samsung will announce momentarily that it will immediately reduce it's plowback ratio to 1/3. find the intrinsic value of the stock.

e. The market is still unaware of this decision. Explain why V0 no longer equals P0 and why.

answers to a and b are 10.60 and 3.53 respectively

Answer 1

Answer (a):

k = Cost of equity = Rf + Beta * (Rm - Rf) = 6% + 1.25 * (14% - 6%) = 16%

Growth = ROE * Retention ratio = 9% * 2/3 = 6%

D1 = Dividend next year = E₀ * (1 + g) * (1 - b) = 3 * (1 + 6%) * (1 - 2/3) = $1.06

P₀ = Price of share = D1 / (k - g) = 1.06 / (16% - 6%) = 1.06 / 10% = $10.60

Price at which Samsung stock should sell = $10.60

Answer (b):

Leading P/E ratio = P₀ /E₁ = 10.60 / 3 * (1 +6%) = 10.60 / 3.18 = 3.33

Trailing P/E ratio = P₀ / E₀ = 10.60 / 3 = 3.53

Hence:

Leading P/E ratio = 3.33

Trailing P/E ratio = 3.53

Answer (c):

PVGO = P₀ - E₁ / k = 10.60 - (3.18 / 16%) = - $9.275

PVGO is negative since ROE is 9% but required return is 16%

PVGO = -$9.275

Answer (d):

If plow back ratio is reduced to 1/3

Growth = ROE * Retention ratio = 9% * 1/3 = 3%

D1 = Dividend next year = E₀ * (1 + g) * (1 - b) = 3 * (1 + 3%) * (1 - 1/3) = $2.06

P₀ = Price of share = D1 / (k - g) = 2.06 / (16% - 3%) = 2.06 / 13% = $15.85

Intrinsic value of the stock = $15.85

As HOMEWORKLIB's policy I have answered 4 parts.