Question

Driver Products recently paid its annual dividend of $2, and reported an ROE of 15%. The firm pays out 50% of its earnings as dividends. The stock has a beta of 1.44. The current risk-free rate is 2.5% and the market return is 11%. Assuming that CAPM holds, what is the intrinsic value of this stock?

Answer 1

Answer:

$29.70

Explanation:

Retention ratio = 1 - payout ratio

= ( 1  -0.5 )

= 0.5

Growth rate, g = ROE × Retention ratio

= 0.15 × 0.5

= 0.075

= 7.5%  

Required return = Risk - free rate + [ Beta × (Market rate- risk-free rate) ]

= 2.5% + 1.44 × (11% - 2.5%)

= 14.74%

Intrinsic value = $\frac{\textup{D1}}{\textup{(Required return-Growth rate) }}$

=$\frac{\textup{2}\times(1+0.075)}{\textup{(0.1474-0.075) }}$

= 29.69 ≈ $29.70