Question

76) Tangshan Antiques has a beta of 1.40, the annual risk-free rate of interest is currently 10 percent, and the required return on the market portfolio is 16 percent. The firm estimates that its future dividends will continue to increase at an annual compound rate consistent with that experienced over the 2000-2003 period. Year 2000 2001 2002 2003 Dividend $2.70 2.95 3.25 3.40 (a) Estimate the value of Tangshan Antiques stock (b) A lawsuit has been filed against the company by a competitor, and the potential loss has increased risk, which is reflected in the company's beta, increasing it to 1.6. What is the estimated price of the stock following the filing of the lawsuit. Answer: (a)

Answer 1

Cost of equity = risk free rate + beta * (market return - risk free return)

= 10% + 1.4 * (16 - 10)%

= 18.4%

Growth rate of dividend = (3.4/2.7)^(1/3) -1

= 8%

Ans a) Stock price = last year dividend * ( 1 + growth rate)/(return on equity - growth rate)

= 3.4 * 1.08 /(.184 - .08)

= $35.31

Ans b) Cost of equity = 10% + 1.6*(16 - 10)%

= 19.6%

Stock price = last year dividend * ( 1 + growth rate)/(return on equity - growth rate)

= 3.4 * 1.08/(.196 - .8)

= $31.66