Question

Rose Hill Trading Company is expected to have EPS in the upcoming year of $6. The expected ROE is 18%. An appropriate required return on the stock is 14%. If the firm has a plowback ratio of 70%, its intrinsic value should be _____.
A) $69.77
B) $150
C) $128.57
D) $20.93

Answer 1

Answer:

We know the company's ROE and plowback ratio, and we can use these 2 figures to find out the future growth rate of the company. In order to do this we need to multiply the ROE by plowback ratio.

0.18*0.7=0.126= 12.6%

We can also find the company's dividend, by (1- plowback ratio) we get how much percentage of the earning is the company distributing as dividends.

(1-0.7)= 0.3 which is the dividend payout ratio

Dividend= Dividend payout ratio *EPS

0.3*6=1.8

This dividend is the dividend which the company will pay in the upcoming year after which they will have a constant growth rate, so in order to find the intrinisc value now, we need to find the intrinsic value of the stock will be in the upcoming year using the upcoming years dividend and then discount that value by the required return of the stock to get the current years intrinsic value.

Now we can use the DDM formula to find the intrinsic value of the stock in the upcoming year.

The formula for DDM is D*(1+G)/(R-G)

D= 1.8

G= 0.126

R=0.14

1.8*(1+G)/0.14-0.126

=144.77

Discount it to find the present value

144.77/1.14

=128.5

The intrinsic value of the stock should be 128.5

Explanation: