Merryweather's Share Price Calculation

Merryweather's Share Price Calculation

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Merryweather, a manufacturer of summer casual wear, has a return on equity of about 10.6%. It typically pays out about 27% of its earnings as dividends. The firm's stock has a beta of +0.23. The market has an expected return of 16.2% and the prevailing risk-free rate is 6.9%. Merryweather recently announced that last year's EPS was $4.3 per share. Given these data, Merryweather's share price should be:

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A. B. C. D.

C

The dividend growth rate, g = ROE*(1-payout ratio) = 0.106*(1-0.27) = 7.738%.

The dividend this year was 4.3*0.27 = $1.16. Therefore, expected dividend next year = D1 = (1+g)*Do = 1.07738*1.16 = $1.25.

The required rate of return on the stock can be found using CAPM, which gives Rstock = Rf + beta*(Rm - Rf) = 6.9% + 0.23*(16.2% - 6.9%) = 9.039%.

Therefore, Po = D1/(k-g) = 1.25/(9.039% - 7.738%) = $96.07.

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