Problem 3 All equity company X trades at a P/E multiple of 25 and is priced...
Problem 3
All equity company X trades at a P/E multiple of 25 and is priced correctly under Gordon’s model. It has a beta of 1.2. Risk-free rate of return is 3% and the return on the market portfolio is 14%. The company pays out 40% of its earnings as dividends. The expected dividend next year is $1.50 per share. Find ROE.
Homework Answers
D1 = $1.50
EPS1 = 1.50/0.40
EPS1 = $3.75
Price = 25(3.75) = $93.75
Using CAPM Model,
Cost of equity = 0.03 + 1.20(0.14 - 0.03)
Cost of equity = 16.20%
Using Constant Growth Model,
g = 0.1620 - 1.50/93.75
g = 14.60%
0.1460 = (1 - 0.40)ROE
ROE = 24.33%
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Problem 3
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