The stock of company XYZ is currently price at $80 per share. It’s earnings this year (T=0) are $4.00 per share. It has paid out a dividend equal to 40% of its earnings for the past several years. It’s Return on Equity (ROE) has been 18%.
1. What is the company’s current Dividend Yield?
Dividend Discount Model
The market expects that companies similar to XYZ will display a rate of return of 13% per year
2. What is the company’s expected Growth Rate for Earnings & Dividends?
3. What dividends will the company pay this year (D0) and be expected to pay next year (D1)?
4. What is the estimated value of the stock today (T=0) using the Dividend Discount Model?
5. What is the estimated value of the stock 1 year from today (T=1)?
Capital Asset Pricing Model (CAPM)
The current risk free interest rate is 2%
The market as a whole is expected to realize a return of 15% this year
XYZ’s stock has historically displayed a Beta of 0.9
6. Using the CAPM, what is the required rate of return that investors would demand of XYZ this year?
7. If the required rate of return as calculated in (5) were used in the dividend discount model, what would be an appropriate value for XYZ’s stock today (T=0)?
8. If the Price / Earnings ratio for XYZ during similar stages of the business cycle had ranged from 16x to 22x, what would be the range of values for its stock?