Answer to Question #59751 in Finance for Noja
estimates that the current risk-free rate is 6.25 percent, the market risk premium is 5
percent, and that Biostar Inc beta is 1.75. The current earnings per share (EPS0) isRM2.50.
The company has a 40 percent payout ratio. The analyst estimates that the company's
dividend will grow at a rate of 25 percent this year, 20 percent next year, and 15 percent
the following year. After three years the dividend is expected to grow at a constant rate of
7 percent a year. The company is expected to maintain its current payout ratio. The analyst
believes that the stock is fairly priced. What is the current price of the stock?
P0 = D0*(1 + g)/(r - g) = D1/(r - g), where P0 = the stock price at time 0, D0 = the current dividend, D1 = the next dividend (i.e., at time 1), g = the growth rate in dividends, and r = the required return on the stock, and g < r.
Payout Ratio = Dividends per Share (D) / Earnings per Share (EPS), so D0/2.5 = 0.4, D0 = 2.5*0.4 = $1 per share.
D3 = D0*1.25*1.2*1.15 = 1*1.725 = $1.725 per share.
Expected market return r = rf + b*(rm - rf) = 0.0625 + 1.75*(0.0625 - 0.05) = 0.084.
The current price of the stock P0 = 1.725*(1 + 0.07)/(0.084 - 0.07) = $131.84 per share.
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