Problem 6 (15 marks)

Company JUK has a ROE of 25% and the company will not pay any dividend for the next 3 years. It is estimated that the company will pay $2 dividend per share after three years and then to level off to 5% per year forever.

The company has a beta of 2. Assume the risk-free interest rate is 4%, and the market risk premium is 8%.

1.What is your estimate of the fair price of a share of the stock?

2.If the market price of a share is equal to this intrinsic value, what is the P/E ratio?

3.What do you expect its price to be 1 year from now? Is the implied capital gain consistent with your estimate of the dividend yield and the market capitalization rate?