a)

Book Value per share = Book value of common equity / total common shares outstanding = 22,000,000 / 2,500,000 = $8.8 per share

P/E = Market price per share / Earnings per share = 46 / 8.86 = 5.19

b)

Using CAPM,

Required return = Risk free rate + Beta x Market risk premium

16% = Risk free rate + 1.25 x Market risk premium

14% = Risk free rate + 1 x Market risk premium

16 - 14 = (1.25 - 1) x Market risk premium

Market risk premium = 2 / 0.25 - 8%

16% = Risk Free rate + 1.25 x 8

Risk free rate = 16 - 10 = 6%

So for a beta of 1.6,

Required return = 6 + 1.6 x 8 = 18.8%

c.

If there is no growth in the dividends, Share Price = Dividend / Required rate of return = 4.7 / 0.188 = $25

d.

If there is growth rate of 8%,

Share Price = 4.7 x (1 + 0.08) / (0.188 - 0.08) = $47

I want an answer from part E. Or if part A-D have anything wrong, welcome to point out. Thank you guys.

Question 1 In the world of high-end audio amplifiers, having an edge on technology and craftsmanship are prerequisites to success. Professor Henry King had both. This year, his audio equipment company, King Audio, rocked to $500 million in sales after 10 years in business. His amplifier lines covered from pure digital Class-D amplifier to audiophiles delight tube-amplifier. King Audio won numerous industry awards and sold the products to those wealthy audiophiles in America and Europe. King Audio had made it and its growth was so remarkable that no one could have foreseen. However, securities analysts speculated that the company could not keep up the pace. They warned that fierce competition in the hi-fi industry might push the firm to encounter little or zero growth in future. They estimated that dividend to stockholders will be flat in coming years. Contrary to securities analysts' prediction, Professor King felt that his company could maintain a constant growth with annual dividend growth rate of 8% to shareholders in future. His optimism is based on the launch of a long-term expansion plan into Asian markets, especially in Japan and Singapore, in coming months. However, venturing into Asian markets is expected to increase the risk of the firm - analysts' consensus is that beta () of King Audio will be increased from the current 1.25 to 1.60 as a result. In preparing the launch of the long-term expansion plan, King Audio's chief financial officer, Peter Prince, has assigned you to evaluate the firm's current value and stock price. He wants you to consider the conservative prediction of the securities analysts as well as the aggressive prediction from the founder Professor King. Prince has provided the following 2020 financial data to aid your analysis: Data Item Earnings per share (EPS) Market price per share of common stock Book value of common stock equity Total common shares outstanding Current common stock dividend per share 2020 value $8.86 $46.60 $22,000,000 2,500,000 $4.70 King Audio CAPM Scenario Table Beta (B.) 0 0.25 0.5 0.75 1 1.25 1.5 1.75 2 Required return (%) 6 8 10 12 14 16 18 20 22 1 Requirements: (a) Determine the book value per share and the current P/E ratio of the firm. (16 marks) (b) Utilizing the capital asset pricing model (CAPM), assess the required return (34 marks) and risk premium of King Audio stock if beta coefficient of the firm (Bi) is 1.25 and 1.6 respectively. (Hint: looking into the CAPM Scenario Table above to find out the market return (Rm) and the risk-free rate (RD) first). What relationship you have observed on the required return and risk premium of King Audio if beta increase as expected? (8 marks) (c) If King Audio has constant, no growth dividend in future and beta has gone up to 1.60 as predicted by securities analysts, what will the share price of King Audio? (8 marks) (d) If Professor King's prediction is correct, what will be the value of King Audio's share if the firm maintains constant 8% annual growth rate in its dividends and a beta of 1.60? (e) Compare the current share price of King Audio and the stock values found (34 marks) in parts (a), (c), and (d). Discuss why these values may differ. From your analysis, which side do investors believe? The prediction from securities analysts or the prediction by Professor King? Finally, what insight you can find between market consensus and CAPM? -End- 2. Question 1 In the world of high-end audio amplifiers, having an edge on technology and craftsmanship are prerequisites to success. Professor Henry King had both. This year, his audio equipment company, King Audio, rocked to $500 million in sales after 10 years in business. His amplifier lines covered from pure digital Class-D amplifier to audiophiles delight tube-amplifier. King Audio won numerous industry awards and sold the products to those wealthy audiophiles in America and Europe. King Audio had made it and its growth was so remarkable that no one could have foreseen. However, securities analysts speculated that the company could not keep up the pace. They warned that fierce competition in the hi-fi industry might push the firm to encounter little or zero growth in future. They estimated that dividend to stockholders will be flat in coming years. Contrary to securities analysts' prediction, Professor King felt that his company could maintain a constant growth with annual dividend growth rate of 8% to shareholders in future. His optimism is based on the launch of a long-term expansion plan into Asian markets, especially in Japan and Singapore, in coming months. However, venturing into Asian markets is expected to increase the risk of the firm - analysts' consensus is that beta () of King Audio will be increased from the current 1.25 to 1.60 as a result. In preparing the launch of the long-term expansion plan, King Audio's chief financial officer, Peter Prince, has assigned you to evaluate the firm's current value and stock price. He wants you to consider the conservative prediction of the securities analysts as well as the aggressive prediction from the founder Professor King. Prince has provided the following 2020 financial data to aid your analysis: Data Item Earnings per share (EPS) Market price per share of common stock Book value of common stock equity Total common shares outstanding Current common stock dividend per share 2020 value $8.86 $46.60 $22,000,000 2,500,000 $4.70 King Audio CAPM Scenario Table Beta (B.) 0 0.25 0.5 0.75 1 1.25 1.5 1.75 2 Required return (%) 6 8 10 12 14 16 18 20 22 1 Requirements: (a) Determine the book value per share and the current P/E ratio of the firm. (16 marks) (b) Utilizing the capital asset pricing model (CAPM), assess the required return (34 marks) and risk premium of King Audio stock if beta coefficient of the firm (Bi) is 1.25 and 1.6 respectively. (Hint: looking into the CAPM Scenario Table above to find out the market return (Rm) and the risk-free rate (RD) first). What relationship you have observed on the required return and risk premium of King Audio if beta increase as expected? (8 marks) (c) If King Audio has constant, no growth dividend in future and beta has gone up to 1.60 as predicted by securities analysts, what will the share price of King Audio? (8 marks) (d) If Professor King's prediction is correct, what will be the value of King Audio's share if the firm maintains constant 8% annual growth rate in its dividends and a beta of 1.60? (e) Compare the current share price of King Audio and the stock values found (34 marks) in parts (a), (c), and (d). Discuss why these values may differ. From your analysis, which side do investors believe? The prediction from securities analysts or the prediction by Professor King? Finally, what insight you can find between market consensus and CAPM? -End- 2