Assume an all equity firm has been growing at a 10 percent annual rate and is expected to continue to do so for one more year, before a year of 5% growth. After that growth is expected to slow to a constant 3 percent rate or the foreseeable future. The firm maintains a 20 percent payout ratio, and this year’s retained earnings before dividends are expected to be $1.2 million. The firm’s beta is 1.25, the risk-free rate is 8 percent, and the market risk premium is 5.6 percent. If the market is in equilibrium, what is the expected market value of the firm’s common equity (1 million shares outstanding)?
Please comment on why you might anticipate the actual market price to vary from the expected value as estimated, and how the variation might affect your likelihood to trade the share.