Case summary:
Person C and Person GR are the founder and owners of the R Company. This company commercially produces and installs heating, ventilation, and cooling units (HVAC). Both the owners have 50,000 shares of the company’s stock as per the
The R Company has earnings per share of $4.85 and dividends of $75,000 each were paid to the owners of the company. Moreover, there is even the
Characters in the case:
R Company: The firm wants to value their stocks.
Person C: Co-owner of Company R.
Person GR: Co-owner of Company R.
To determine: The estimate of the stock price on assumption of growth rate.
Answer to Problem 2CC
The estimate of stock price is $41.33.
Explanation of Solution
Given information:
The earnings per share are $4.85, Return on equity (ROE) is 17%, and required rate of return is 14%. The earnings per share without of written off are $0.54. The earnings per share of AC Company are $0.84 and NH Company (both are competitors) is $1.34.
The industry average of earning per share is $0.54, dividend per share is $0.49, and return is 11.67%.The industry average ROE is 15% and the dividend per share paid in the current year is $1.5 (Refer previous problem-computed value).
Formulae:
The formula to calculate the industry (competitor’s) earnings per share:
The formula to calculate the industry payout ratio:
The formula to calculate the industry retention ratio:
The formula to calculate the industry growth rate:
The formula to calculate the total dividends of next year:
Where,
D1 refers to the next period expected dividend per share.
The formula to calculate the stock price in Year 5:
The formula to calculate the current total value of the stock price:
Where,
Po refers to the price of the stock.
D1 refers to the next period expected dividend per share.
R refers to the required rate of return on its stock.
grefers to the constant rate of growth.
Compute the industry earnings per share:
Hence, the industry earnings per share are $0.91.
Compute the industry payout ratio:
Hence, the industry payout ratio is 0.5384 or 53.84%.
Compute the industry retention ratio:
Hence, the industry retention ratio is 0.4616 or 46.16%.
Compute the industry growth rate:
Hence, the industry growth rate of the company is 0.0692 or 6.92%.
Note: The Company has continued to grow in the current pace for five years before the slowdown of industry growth rate. As a result, compute the total dividends for each of the next 6 years.
Compute the dividend for Year 1:
Hence, the dividend for Year 1 is $1.68.
Compute the dividend for Year 2:
Hence, the dividend for Year 2 is $1.87.
Compute the dividend for Year 3:
Hence, the dividend for Year 3 is $2.09.
Compute the dividend for Year 4:
Hence, the dividend for Year 4 is $2.34.
Compute the dividend for Year 5:
Hence, the dividend for Year 5 is $2.61.
Compute the dividend for Year 6:
Hence, the dividend for Year 6 is $2.79.
Compute the stock price in Year 5:
Hence, the stock price of Year 5 is $58.74.
Compute the stock price:
Hence, the stock price is $41.33.
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Chapter 7 Solutions
Essentials of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
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