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Calculate the expected cost and predicted value of an equity share in Shiny plc if its earnings per share is $0.80 with a constant annual dividend payout ratio of 25%.
Note:
Shiny plc has equity beta of 1.2.
The risk-free rate of return is 5%
The market rate of return is 8%a Expected cost = 8.6%; Predicted value = $2.33
b Expected cost = 20.6%; Predicted value = $3.88
c Expected cost = 3.6%; Predicted value = $5.56
d Expected cost = 8.6%; Predicted value = $9.30Answer – A
I calculated expected cost using this formula
Expected return = rf + beta (rm-rf)
= 5 + 1.2 (8-5)
= 8.6%.Could you explain how to find out the predicted value only?
Thanks a lot,
You use the dividend valuation formula.
The dividend is 25% x $0.80 = $0.20 per share.
There is no choice but to assume that the earnings and therefore the dividend are constant, so g = 0.
Re = 8.6% (as you have calculated).Therefore the share price = 0.20 / 0.086 = $2.33 per share.
I do suggest that you watch my free lectures on the valuation of securities. The lectures are a complete free course for Paper F9 and cover everything needed to be able to pass the exam well.
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