When valuing a company and you find that your estimated value of the firm differs substantially from the market value of the firm, what do you think could cause this big discrepancy? Explain the steps you will take to make sure that your estimate is reliable?
Harrison Company reported earnings of $4 million and its return on equity is averaging 14%. The company plans to retain 30% of its earnings. The company has a Beta of 1.8 and the average market return for companies with high risk is around 13%.
The 5 year US Government Treasury Bond rate is around 3% company. The company plans to pay a dividend of $2.0 today.
(a) If you are an investor, what will be the maximum price you will pay for the company stock?
(b) If the stock is selling at $25 will you buy it? Why? What growth rate is implied in this stock price?
(c) If investors believe that the company risk will decline, and therefore its beta will change with a change in risk, and with investors required rate of return of 12%; what is the beta of this stock given that the market risk premium remains the same.