Following the example of those who post questions here: A company is expected to earn $4.00 per share next year. Its current book value per share is $40.00. The long-term growth rate of the company is 6% per year. If the company has a cost of common equity capital of 11% and is selling at a price of $35 per share, the company’s shares are: a) overvalued b) undervalued c) correctly valued d) selling at a price to book value
b… V = E1/r + PVGO 4/.11 = 36.36 plus a PVGO
I chose a. not sure though. i got justified p/b to be .8 and mutliplied that by book value of 40, to get 32. stock is at 35, so overvalued.
thats a good point cfasf1… i bet your right
Chap i think its best to use this formula… Vo= B0 +( (Roe-r) x Bo))/ (R-G) Bo = 40 Roe = 4eps/40bk value = .10 R = .11 G = 6 Vo= B0 +( (Roe-r) x Bo))/ (R-G) Problem occurs when ROE is lower than R so you have to default to V = E1/r + PVGO I get B as well
funny, i was going to say the same thing about your answer, chadtap.
Nice job cfas1 if its right. I looked at this question dumbfounded on how to get ROE. For some reason simply taking 4/40 didn’t occur to me.
hey guys answer is A. Nice work CFASF, it did not occur to me either to use the P/BV relation. Below are the calculations: The company is selling at a price-to-book value of $35/$40 = 0.875. Therefore, it is overvalued relative to its justified price-to-book value ratio of 0.80. To arrive at the justified price-to-book value, one must first solve for the projected return on equity for the company. Then the price-to-book value may be calculated. This would result in an intrinsic stock price of: Since $32 < $35, the stock is overvalued.
sorry the ROE and BV formulas for those who don’t wanna open the books are: E/BV = 4/40 = 0.1 P/BV = ROE - G / Rce - G = 0.1 - 0.06 / 0.11 - 0.06 = 0.8
well hopefully we dont get questions like that in the exam where different formulas will arrive at very differnt ans… good work!
chadtap…just thought id mention…for your initial post where you got to B since 4/.11 = 36.36 + PVGO you assumed PVGO would be a positive number and hence got the answer B…this might not be the case…clearly in this example…PVGO must be negative…that’s why the stock is overvalued… not trying to point out mistakes…just wanna make sure even I’ve understood this correctly…since I too used the P/BV calculation…would’ve never though of using V = E/r +PVGO
Yes mumukada, thats a great point you picked up on. Actually I should have seen that coming because ROE was less then R (hence probably negative NPV projects), which I mentioned and still I assumed positive PVGO. CFASF1 did it the other way and got the right answer… nice job.
^^yeah you guys are right on that…thankfully we still have 40 days!
I calculated the value this way. Roe * b = growth ROE = 4/40 = .10 growth = .06 So b= .6 Dividend would then be .4*4= 1.6 Using the model 1.6*(1+1.06) / .11-.06 = 33.92 which is < 35
^^ yeah I guess that works too…
dancingqueen Wrote: ------------------------------------------------------- > I calculated the value this way. > > Roe * b = growth > > ROE = 4/40 = .10 > growth = .06 > > So b= .6 > > Dividend would then be .4*4= 1.6 > > Using the model 1.6*(1+1.06) / .11-.06 = 33.92 > which is < 35 Careful here, we’re already at E1 so we don’t need to multiply it by g.