On the basis of the following information: Current dividend (Do) = 5Discount rate (k) = 10.5%Growth rate (g) = 4% (i) Calculate the present value of…
CA Final · Advanced Financial Management · MTP · May 2024
On the basis of the following information: Current dividend (Do) = 5Discount rate (k) = 10.5%Growth rate (g) = 4% (i) Calculate the present value of stock of ABC Ltd. (ii) Evaluate whether the stock is overvalued if stock price is 70, ROE = 18% and EPS (Eo) = 4.50 applying: (1) PE Multiple Approach and (2) Earning Growth Model (using discount rate of 10.5%).
Suggested Answer and Working Notes:
(a) (i) Present Value of the stock of ABC Ltd. is:- Vo = 5(1.04) / (0.105-0.04) = 80/-. (ii) (A) Value of stock under the PE Multiple Approach Particulars Actual Stock Price 70.00 Return on equity 18% EPS 4.50 PE Multiple (1/Return on Equity) = 1/18% 5.56 Market Price per Share 25.02 Since, Actual Stock Price is higher, hence it is overvalued. (B) Value of the Stock under the Earnings Growth Model Particulars Actual Stock Price 70.00 Return on equity 18% EPS 4.50 Growth Rate 4% Market Price per Share [EPS ×(1+g)]/(Ke − g) 72 = 4.50x 1.04 / (0.105-0.04) Since, Actual Stock Price is lower, hence it is slightly undervalued.
Topics: Security Valuation
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