
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.
Want to see more full solutions like this?
Chapter 7 Solutions
Essentials of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
- What is the full form of "ATM"? a.Auto Teller Machine b.Automatic Teller Machine c.Automated Teller Machine d.Authorized Teller Machinearrow_forwardWhich of the following risks is indicated by the beta coefficient in Financial Management? a.Adjusted risk b.Non diversifiable risk c.Diversifiable risk d.None of thesearrow_forwardWhat is the full form of "EPS"? a.Exchange per Share b.Equity Private Selling c.Earnings per share d.Earning Preferred Stockarrow_forward
- What indicate the relationship between interest rate and reinvestment rate a.Positive b.Perfectly negative c.Zero d.Negativearrow_forwardWhat is the full form of "MMKT"? a.Middle Market b.Management Key Trading c.Money Market d.Mutual Market Tradingarrow_forwardYellow Ocean Paint is evaluating Project A. In year 3, Yellow Ocean Paint would have revenue of $688,000 and costs of $314,000 if it pursues Project A, and the firm would have revenue of $579,000 and costs of $219,000 if it does not pursue Project A. Depreciation taken by the firm in year 3 would be $216,000 if the firm pursues the project and $162,000 if the firm does not pursue the project. The tax rate is 20 percent. What is the operating cash flow for year 3 that Yellow Ocean Paint should use in its NPV analysis of Project A? Input instructions: Round your answer to the nearest dollar. 22,000 dollarsarrow_forward
- The excess of the present value of benefits over the present value of costs of a course of Action is called as: a.All of these b.Benefits c.Wealth d.Payoffarrow_forwardThe decisions relating to the use of profits or income of an entity or organization are known a.Any of these b.Dividend decisions c.Finance decisions d.Investment Decisionarrow_forwardWhat are the three interrelated areas of finance? (a) Financial markets, option and forwards (b) Banking, financial institutions and swap currency (c) Investment, Financial management and Financial market & Financial institution (d) All of abovearrow_forward
- The method that converts the amount of present cash into an amount of cash of equivalent value in future is: a.Budgeting b.Both a and b c.Discounting method d.Compounding methodarrow_forwardThe government finance which includes the principles and practices relating to the Procurement and management of funds for Central Government, and Local bodies is known as: a.Public Finance b.All of these c.Private Finance d.Business Financearrow_forwardwhat is financial ratios?arrow_forward
- Cornerstones of Cost Management (Cornerstones Ser...AccountingISBN:9781305970663Author:Don R. Hansen, Maryanne M. MowenPublisher:Cengage LearningAuditing: A Risk Based-Approach to Conducting a Q...AccountingISBN:9781305080577Author:Karla M Johnstone, Audrey A. Gramling, Larry E. RittenbergPublisher:South-Western College Pub

