QUESTION 3 – Valuing Stocks – 20 marks Your CFO has sent you three analyst reports...

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QUESTION 3 – Valuing Stocks – 20 marks
Your CFO has sent you three analyst reports for a young, growingcompany that you are interested in acquiring. These reports depictthe company as speculative, but each one poses differentprojections of the company’s future growth rate in earnings anddividends. All three reports show that the company recorded anearnings per share (EPS) of $1.20. The company just paid 40% of itsearnings as dividends. There’s consensus that market rate of return(expected rate of return) to investors for this share is 14percent, and that company’s management expects to consistently earna 15 percent return on equity (ROE = 15 percent).
REPORT A
The analyst who produced report A makes the assumption that thecompany will remain a small, regional company that, althoughprofitable, is not expected to grow. Therefore,the company expects to pay the same dividend per share in futureyears.
Based on this report, what model can you use tovalue a share in the company? Using this model, what is the valueof a share?
REPORT B
The analyst who produced report B makes the assumption that thecompany will enter the national market and grow at aconstant rate i.e. at the company’s current sustainablegrowth rate.
Based on this report, what model can you use tovalue a share in the company? Using this model, what is the valueof a share?
REPORT C
The analyst who produced report C also makes the assumption thatthe company will enter the national market but expects a high levelof initial excitement for the product that is then followed bygrowth at a constant rate.
Earnings and dividends are expected to grow at a rate of50 percent over the next year (i.e. year 1), 20percent for the following two years (year 2 and year 3),and then revert back to the company’s constant growth ratewhich is the company’s current sustainable growthrate.
Based on this report, what model can you use tovalue a share in the company? Using this model, what is the valueof a share?
Comment on the different valuations you have justdone

Answer & Explanation Solved by verified expert

4.0 Ratings (504 Votes)

Report A The perpetual dividend model can be used to value the share Value of share in perpetual dividend model dividend required return of shareholders Value of share 120 40 14 343 Report B The constant growth model can be used to value the share Value of share in constant growth model next year dividend required return of shareholders See Answer

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QUESTION 3 – Valuing Stocks – 20 marksYour CFO has sent you three analyst reports for a young, growingcompany that you are interested in acquiring. These reports depictthe company as speculative, but each one poses differentprojections of the company’s future growth rate in earnings anddividends. All three reports show that the company recorded anearnings per share (EPS) of $1.20. The company just paid 40% of itsearnings as dividends. There’s consensus that market rate of return(expected rate of return) to investors for this share is 14percent, and that company’s management expects to consistently earna 15 percent return on equity (ROE = 15 percent).REPORT A The analyst who produced report A makes the assumption that thecompany will remain a small, regional company that, althoughprofitable, is not expected to grow. Therefore,the company expects to pay the same dividend per share in futureyears.Based on this report, what model can you use tovalue a share in the company? Using this model, what is the valueof a share?REPORT BThe analyst who produced report B makes the assumption that thecompany will enter the national market and grow at aconstant rate i.e. at the company’s current sustainablegrowth rate.Based on this report, what model can you use tovalue a share in the company? Using this model, what is the valueof a share?REPORT CThe analyst who produced report C also makes the assumption thatthe company will enter the national market but expects a high levelof initial excitement for the product that is then followed bygrowth at a constant rate.Earnings and dividends are expected to grow at a rate of50 percent over the next year (i.e. year 1), 20percent for the following two years (year 2 and year 3),and then revert back to the company’s constant growth ratewhich is the company’s current sustainable growthrate.Based on this report, what model can you use tovalue a share in the company? Using this model, what is the valueof a share?Comment on the different valuations you have justdone