Calculate the value of a stock based on the following information: Sales = $1.0 billion Assets = $1.5 billion Debt-to-Equity = 30% EBT Margin = 20% Tax Rate = 40% Real Risk-free Rate = 4% Expected Inflation = 3% Beta = 1.2 Market Risk Premium = 8% Current EPS = $3.00 a. $5.25 b. $8.50 c. $9.08 d. $8.41 I get d. $8.41 using the P/E in DDM, but this is incorrect according to the answer key. What do you think?

do you have the retention rate, the dividend payout or the dividend?

lol yeah i’ve been trying to solve this for the past 5 minutes and i feel like i need more info

yes, you need one of those

Really sorry about that, yes the dividend pay out ratio is 25%.

So, is it C?

Yes, the book says C. I agree if you do the DDM but using the PE model it think it should be D.

EBT margin = 20%=> EBT=0.2*sales=0.2*1bil=0.2bil NI=(1-tax rate)*EBT=0.6*0.2bil=120mil D/E=0.3=>E=A/1.3=1.5bil/1.3=1.15bil ROE=NI/E=0.12/1.15=10.4% g = ROE*RR=ROE*(1-dividend payout)=10.4*0.75=7.8 Current Dividend=dividend payout *EPS=0.25*3=0.75 Next dividend = 0.75*1.078=0.81 Required return = Risk free rate + beta *market risk premium = ((1+real risk free)*(1+expected inflation) -1)+ beta *market risk premium = ((1.04*1.03)-1)+1.2*0.08=16.72% Price = Next Dividend/(Required return – growth rate)=0.81/(16.72%-7.8%)=9.08072

you can go with risk free rate= real risk free+expected inflation, but it gets you a slightly higher number.

map1, I completely agree with your calculations but I also believe mine are correct as well. [.25/(.1672-.078)] * 3 = $8.41 My question is on the real test I am assuming they will specify what method to use to calculate the price. Correct?

I got $9.2 closest to C.

Whodey - Question says Current EPS = $3.00; to get next years EPS multiply by growth rate (factor of 1.078)… So ans will be 8.41*1.078 = $9.07 Price = D1/(k-g) D1 = Next years EPS*Div Payout = 3*0.25*1.078

yeah that’s D1, but he’s asking about this equation: P0/E1 = (D1/E1)/(k-g) which gives you a different result.

I don’t know where I am thinking wrong, but either equation should give 9.08. P0/E1=(D1/E1)/k-g = P0/E1 = Dividend payout/(k-g) —> P0/E1=0.25/(0.1672-0.078) = 2.8 P0 = 2.8*E1 = 2.8*(1.078*3) = 9.06 He is using E0 and not E1 in the equation, and getting different result (or may be I just got back fro work