Problem Set 1

{. How many consecutives years the company has been profitable, its current ration and its ROE

Problem Set 2 is to be completed by 11:59 p.m. (ET) on Monday of Module/Week 4.

The EPS of the company is Rs. 15. The market rate of discount applicable to the company is 12%. The dividends are expected to grow at 10% annually. The company retains 70% of its earnings. Calculate the market value of the share using the Gordon’s model.

Solutions to Valuation Questions 1. Assume you expect a company’s net income to remain stable at $1,100 for all future years, and you expect all earnings to be distributed to stockholders at the end of each year, so that common equity also remains stable for all future years (assumes clean surplus). Also, assume the company’s β = 1.5, the market risk premium is 4% and the 20-30 year yield on risk free treasury bonds is 5%. Finally, assume the company has 1,000 shares of common stock outstanding. a. Use the CAPM to estimate the company’s equity cost of capital. • re = RF + β * (RM – RF) = 0.05 + 1.5 * 0.04 = 11% b. Compute the expected net distributions to stockholders for each future year. • D = NI – ΔCE = $1,100 – 0 = $1,100 c. Use the

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The firm employs about 190,000 people and boasts the 20 million strong consumer base with projected growth 3.5 million within the next three years. The firm’s Price-to-Earnings Ratio (P/E) of about 21 is higher than P/Es of its primary competitors. Hence, CVS reported 21 bps increase and the total gain of $68 million in the last year. At the same time, the forward earning on the CVS stock yielded over 9.3% allowing the firm easily meets its dividend obligations. The EPS proves that the stock has been performing well at over 30%. The revenue has been growing at 15.7% per year during the last three years compare to 14.2% revenue growth within the industry. This stock's forward earnings yield of 7.41% is the annual return it would generate if its profits remained fixed and it paid out all of its earnings as dividends. This is normal compared with the earnings yields of other stocks in the industry, and is healthy in absolute terms. Finally, most companies in the industry have generated very low returns on assets over the past five years. CVS has posted results that are about average for the industry, though its ROA over the most recent 12 months was very high.

1. Why has the stock price fallen despite the fact that net income has increased over the periods under review?

For Problem 24 we computed the present value of shares of common stock with a constant growth return. Problem 24 breaks down as follows:

In 2014, the rate of inflation was at an all-time low since 2009 of 1.2% (BBC News, 2014), MW’s revenue increase for that year was 1.36% showing that they remained operating healthily. I have worked out that the number of basic shares for 2014 was 65,192,592 and the total dividends were 10,430,814. With their large amount of shares, MW could be liable to depending on shareholders making decisions about their business. According to The London Stock Exchange (2015), the return on investment in a stock from dividend yield is 3.82% for the fiscal year. This is quite a low return, which may suggest that the share is overpriced or that the dividends are likely to be higher in the future. Return on Equity was 18.3% ((23887000/90969000)*100) in 2014, shareholders earned 18% of their investment in the company back, showing an attractive level of investment quality. The Dividend cover is close to risky at 1.68 (0.27/0.16), the company can just about afford the dividends and the dividend pay-out ratio is low at 0.59(0.16/0.27), but has been stable indicating a solid dividend policy from the company. The cash dividend cover is also low at 1.74 (0.27/1.687).

I’ll use a 10 year time horizon so the current 10 year interest rate is: 6.34%

Solutions to Valuation Questions 1. Assume you expect a company’s net income to remain stable at $1,100 for all future years, and you expect all earnings to be distributed to stockholders at the end of each year, so that common equity also remains stable for all future years (assumes clean surplus). Also, assume the company’s β = 1.5, the market risk premium is 4% and the 20-30 year yield on risk free treasury bonds is 5%. Finally, assume the company has 1,000 shares of common stock outstanding. a. Use the CAPM to estimate the company’s equity cost of capital. • re = RF + β * (RM – RF) = 0.05 + 1.5 * 0.04 = 11% b. Compute the expected net distributions to stockholders for each future year. • D = NI – ΔCE = $1,100 – 0 = $1,100 c. Use the

The dividends are expected to grow at a rate of 5.8% per year into the foreseeable future. The price of this stock is now $25.18.

[Copy and paste your answers to the questions marked “WORKBOOK QUESTIONS” from the Week 4 workshop exercises and problem questions and Week 4 seminar questions here. Revise your answers to incorporate any feedback that you have received. For example, feedback receive in class by your Instructor, individually during consultation times, or by way of the weekly summary answers]

6.01%/year, the two-year and the three-year spot rates, r2 and r3 , are both 5%/year.

After a low record of P/E ratio of 11.2% in Y2014, we can saw the ratio was high in Y2015 since the stock price dropped to $4.54 at the end of financial year. Earnings per share jumped around $10 in Y2016 while the share price went up as well to reach $6.19. This generated a lower ratio than the previous year. The ratio dropped again in Y2017 with extreme earnings per share level that reached $90.9 and a stock price of $6.16. The ratio reached as low as 7,17% in by the end of Y2017. That means that investors are willing to pay $7.17 for every dollar of earning per share that Bega Cheese Ltd