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The market consensus is that Dudley Electronic Corporation (DCE) has an ROE = 9%, has a beta of 1
The market consensus is that Dudley Electronic Corporation (DCE) has an ROE = 9%, has a beta of 1.25, and plans to maintain indefinitely its traditional plowback ratio of 2/3. This year’s earnings were $3 per share. The annual dividend has just been paid. The consensus estimate of the coming year’s market return is 14%, and T-bills currently offer a 6% return.
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a) Estimate the value of DCE stock.
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b) Estimate DCE’s P/E ratio.
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c) Estimate DCE’s present value of growth opportunities.
Expert Solution
QA)
Growth rate = ROE*plow back ratio = 0.09*(2/3) = 6%
Dividends are paid from payout ratioD0 = EPS*(1-Plowbackratio)= 3*(1- 2/3)= 1
D1=D0*(1+growth)= 1 *(1+6%) = 1.06
cost of equity= Risk free rate + Beta*(Market return - Risk free rate)
=6+1.25*(14-6)
Cost of equity= 16%
Price of stock = D1/(cost fo equity-growth) = 1/(16%-6%)
Price= $10.00
QB)
P/E= (1-Plowbackratio)/(Cost of equity-growth)
=(1-(2/3)) /(16%-6%)
=1/3 / 0.1
P/E= 3.33
QC)
PVGO= Inrinsic value of share -(EPS/Cost of equity)
=10-(3/16%)
=10-18.75
PVGO = -8.75
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