Chapter 13, Problem 20PS

The market consensus is that Analog Electronic Corporation has an ROE of $\text{9}\%$ and a beta of $\text{1}.\text{25}$ . It plans to maintain indefinitely its traditional plowback ratio of 2/3. This year’s earnings were $\$\text{3}$ per share. The annual dividend was just paid. The consensus estimate of the coming year’s market return is $\text{14}\%$ , and T-bills currently offer a $\text{6}\%$ return. $\left(\text{LO 13}-\text{3}\right)$
a. Find the price at which Analog Stock should sell.
b. Calculate the P/E ratio.
c. Calculate the present value of growth opportunities.
d. Suppose your research convinces you Analog will announce momentarily that it will immediately reduce its plowback ratio to 1/3. Find the intrinsic value of the stock.
e. The market is still unaware of this decision. Explain why ${\text{V}}_0$ no longer equals ${\text{P}}_{\text{0}}$ and why ${\text{V}}_0$ is greater or less than ${\text{P}}_{\text{0}}$ .