In August 2003, Krispy Kreme’s common stock was trading at $44 per share. Several analysts and investors believed at the time that its shares were worth considerably less. They were right |
because by November 2007, the stock was trading below $3 per share.

This problem illustrates how the abnormal earnings valuation model described in Appendix A of this Shes can be combined with security analysts’ published earnings forecasts and used to spot potentially overvalued stocks.

Required:
1. Use the abnormal earnings valuation model from Appendix A of this chapter to derive an estimate of Krispy Kreme’s stock price as of August 2003. A spreadsheet template is available on the textbook Web site. You will need this additional information:
• Actual EPS for 2001 and 2002 were $0.49 and $0.70, respectively.
• The per share amount of stock issued in 2001 and 2002 was $0.65 and $0.39, respectively.
No stock is expected to be issued or bought back during the next five years.
• Other comprehensive income per share was $0.32 in 2002 and zero in 2001. Analysts are forecasting other comprehensive income to be zero each year during the next five years.
• Krispy Kreme does not pay dividends.
• Return on equity, calculated using the beginning-of-year equity book value, was 21.1%
and 20.2% in 2001 and 2002, respectively.
• Analysts are forecasting EPS to be $0.70 and $0.89 in 2003 and 2004, respectively. The estimated long-term EPS growth rate is 13.25% for 2005 through 2007.
• Krispy Kreme’s equity cost of capital is 11%, and the long-term growth rate (beyond 2007) is assumed to be 3%.
2. Why might your value estimate from requirement | differ from the company’s stock price in August 2003?