Question

The market consensus is that Analog Electronic Corporation has an ROE of 9% and a beta of 1.70. It plans to maintain indefinitely its traditional plowback ratio of 2/3. This year's earnings were $3.6 per share. The annual dividend was just paid. The consensus estimate of the coming year's market return is 15%, and T-bills currently offer a 5% return. a. Find the price at which Analog stock should sell. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

Answer:

$7.95

Explanation:

The computation of the price at which the stock should sell is shown below;

But before we need to determine the following calculations

Sustainable growth rate, g is

= ROE × b

= 9% × (2 ÷3)

= 6%

Now

Cost of Equity = Rf + beta × (Rm - Rf)

= 5% + 1.70  ×(15% - 5%)

= 22%  

Now finally the Price is

= D1 ÷ (r - g)

= $3.6 × 1 ÷ 3 × (1 + 6%) ÷ (22% - 6%)

= $7.95