extraordinary

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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You are valuing a high-growth technology firm specializing in car batteries. For 2022 the
company reported EPS of €2.12 and paid a dividend of €0.38 at the end of the year. For 2017
the same company had reported EPS of just €0.48. You are expecting the company to go
through an extraordinary growth phase that will last for another 6 years, then pass through a
transitional period that will last 5 years, and finally enter a stable growth period for the
foreseeable future after that. The beta of the stock is estimated currently at 1.5, it is expected
to remain so for the first period, and then is expected to fall (in a linear fashion) during the
transitional period to its long-term value of 1.05. The risk-free rate is 4% and the risk premium
of the market portfolio is estimated at 6.5%. The Net Income for 2022 is reported to be €5,650
and the book value of equity for 2021 and 2022 is €19,900 and €21,120, respectively. The tax
rate on income is 35%.

i) To calculate the expected dividend growth rate during the first period, you take the
weighted average of three independent estimates: External analysts’ estimate
(weight 40%), historical growth estimate (weight 20%) and fundamentals estimate
(weight 40%). The first one is given to be 25%. Assuming a constant payout ratio for
the extraordinary growth phase, calculate the fundamentals and historical growth (using geometric average) estimates, and find the required weighted average to be used in DDM.

ii) Assume that for the third (stable growth) period the ROE remains constant and equal
to 20% and the expected dividend growth equal to 8%. Also assume that during the
second, transitional period both the growth rate and the payout ratio change in a
linear fashion. Find the expected earnings and dividends for the first two periods.

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