Seattle Software Inc. recently paid an annual dividend of $1.95 per share and is expected...
Seattle Software Inc. recently paid an annual
dividend of $1.95 per share and is expected to grow at a 15% rate
indefinitely. Short-term federal government securities are paying
4%, while an average stock is earning its owner 11%. Seattle is a
very volatile stock, responding to the economic climate two and a
half times as violently as an average stock. This is, however,
typical of the soft- ware industry.
a. How much should a share of Seattle be worth? b. Do you see any
problems with this estimate? Change one assumption to something
more
reasonable and compare the results.
Homework Answers
Solution:
a)Calcuation of share price
Expected return as per CAPM
=Risk Free rate+Beta(Market Rate-Risk Free Rate)
=4%+2.5(11%-4%)=21.5% or 0.215
Calculation of share Price
Share Price=D0(1+Growth rate)/Expected return-Growth rate
=$1.95(1+0.15)/(0.215-0.15)
=$34.50
Thus share price of Seattle is $34.50
b)The growth rate is seems too aggressive even for the soft-ware industry.Growth of 15% is unlikely.Calculating share price assuming growth rate of 6%
Share Price=$1.95(1+0.06)/0.215-0.06
=$31.80
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