Required rate of return of the stock

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You are a financial analyst at Bank of America and you have collected following information for Lotus Tech Company. The company has beta of 1.5 and a ROE of 20%. The dividend payout ratio is 50%. Last twelve month earnings were $4 per share. The annual dividend was just paid. The consensus estimate of the coming year’s market return is 11%, and T-bills currently offer a 8% return.
(keep two decimal places please.)
a. What is the required rate of return of the stock? (input format: 15.32%)
b. What is the growth rate of the stock? (input format: 15.32%)
c. What is the intrinsic value of the stock? (input format: $15.32)
d. What is PVGO of the stock? (input format: $15.32)
e. Suppose your research convinces you that company will announce momentarily that it will immediately change its dividend payout ratio to 75%. Find the intrinsic value of the stock. (input format: $15.32)

Sample Solution

a. The required rate of return of the stock can be calculated using the Capital Asset Pricing Model (CAPM). This model states that the required return of a security is equal to the risk-free rate plus a risk premium reflecting its relative volatility as compared to other assets. The formula for calculating this is: Required Return = Risk Free Rate + β × (Market Return – Risk Free Rate). In this case, we have a beta of 1.5, market return estimate at 11%, and T-bills currently offering 8% so plugging these values in gives us: Required Return = 8% + 1.5 × (11% – 8%) = 15.32%. Therefore, Lotus Tech Company’s required rate of return is 15.32%.

b. Growth rate can be calculated from dividend growth model which states that current share price will equal expected future dividends divided by required rate of return minus growth rate . Since we already know all the constants from our earlier calculation ,we can rearrange this equation to get

Growth Rate= Expected Future Dividends/Current Share Price −Required Return

We know last twelve months earnings were 4 per share and an annual dividend was paid out with 50 % payout ratio so expected future dividends will be 6 per share(0.50*4+4) Plugging all these values in gives us : Growth Rate= 6/40 -15 32*100 or 0 132 or 13 2.

Hence ,Lotus Tech Company’s growth rate is 13 2%.

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