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Hulu Huup Inc
Hulu Huup Inc. has introduced a new line of huups to be used only by consenting adults. In evaluating the company, you believe earnings and dividends will grow at rate of 25% for next two years, after which the growth rate will fall to 6%. The beta of HULU is 0.8, the risk free is 6%, and the market risk premium is 5%. HULU’s most recent annual dividend was $2.00 per share and most recent annual earnings was $3.00 per share.
1) Calculate the equilibrium required rate of return according to CAPM
2) Estimate the fair value of the stock
3) Calculate the present value of growth opportunity
4) If the stock is selling at $75, is the market in equilibrium? If not ,how to achieve?
Expert Solution
Answer : (a.) Calculation of the equilibrium Required Rate of Return :
Required Rate of Return as per CAPM = Risk free rate + (Beta * Market Risk Premium)
= 6% + (0.8 * 5%)
= 10%
(b.) Calculation of Fair Value of Stock :
Fair Value of the stock is the present value of Dividend and Terminal Value :
| Year | Dividend | PVF @10% | Present value of Dividend |
| 0 | 2 | ||
| 1 | 2.50 | 0.909091 | 2.272727273 |
| 2 | 3.125 | 0.826446 | 2.582644628 |
| 2Terminal value | 82.8125 | 0.826446 | 68.44008264 |
| Total | 73.30 |
Terinal value = [Dividend in year 2 * (1 + growth rate)] / [Required Return - Growth rate]
= [3.125 * (1 + 0.06)] / [0.10 - 0.06]
= 82.8125
Value of Stock is 73.30
(c.) Present Value of Growth opportunity = Value of Stock - (EPS / required return)
= 73.30 - (3 / 0.10)
= 43.30
(d.) No the stock is not in equilibrium but is overvalued as market price is more than Intrinsic value.
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