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Question - XYZ Inc. has expected earnings over the next year of $2/share (E1 = 2). The company is expected to maintain an earnings retention rate of 40%, i.e., 60% of earnings are expected to be paid out as dividends every year. The company has a beta of 1.5, the risk-free rate is 4%, and the market risk premium is also 4%. The growth rate of earnings is 5%.
a) According to the CAPM, what is the discount rate of the stock?
b) What should be the value of the stock according to the Gordon Growth Model?
c) What is the expected holding period return over the next year?
d) How much of the expected HPR in (c) is due to capital gains (price appreciation) and how much is attributable to dividend yield?
e) What ROE justifies the growth rate?
f) What is the present value of growth opportunities for this stock?
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