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S PROW LM Melissa is trying to value the stock of Generic Utility
S PROW LM Melissa is trying to value the stock of Generic Utility. Inc Much is clearly not growing at al Generic declared and paid a $6 dividend last yaw I he 'Nulled return for utility stocks is 11%, but Melissa is unsure about the Manual reporting integnty of Generic's finance team She decides to add an extra 1% "credibility" list premium to the required return as part of her valuation analysis a. What is the value of Generic's stock, assuming that the financials are trust.orthy? b. Nhat is the value of Generic's stock, assuming that Melissa includes the extra 1% "credibility' risk prensurn? c. Nfiat is the difference between the values found in parts a and b, and how might one interpret that ciAef entO
a. The expected value of Generic's stock assuming that the required rate of return for ubirtv stocks ,
Expert Solution
a) Computation of value of Generic's stock, assuming that the financials are trustworthy:
Value of stock assuming the financials are trustworthy =Dividend/Required rate of return
= $5/11%
= $45.45
b) Computation of value of Generic's stock, assuming that Melissa includes the extra 1% "credibility" risk premium:
Value adding 1% risk premium = 5/12% = $41.67
c) Computation of Difference between the values found in parts a and b:
Difference between values = $45.45 - $41.67 = $3.78
The difference reflects the fall in value of Stock if the financials are not credible.
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