1)You have been given the following scenario as a company valuation case. The scenario will give you all of the relevant background to forecast earnings at time 1, and retention and IRR rates for years 1-4 as you will find in the main tutorial questions. To aid the introduction to the topic you will also be given a table showing retentions, dividends, incremental earnings and NPVs over the same period but with a number of values missing and additional information to be completed as the prep questions.

Scenario:

Savage plc is a highly profitable company that has grown rapidly in recent years. As the most profitable business locations have now been exploited its management recognises that the rate of return on further investments will tend to be lower than those the company has achieved on its investments in recent years. But while the rate of return on new investments is falling, it remains above the shareholders required rate of return. The company has financed its growth from retentions, and will continue to do so for the next few years.

It is anticipated that the companys earnings next year will be 150 million, and the company will reinvest 80% of its earnings. The company is expected to earn 40% in perpetuity on these investments. The following year the company will again reinvest the same proportion of its earnings, but the rate of return on these investments is expected to fall to 30%. Three years from now the company is expected to earn a rate of return of 25% on its investments, which will be limited to 60% of earnings. This is the last year that the company is expected to produce rate of return above the required rate of return. By year four the companys investments are expected to earn no more than 15%. From year four onwards the company is expected to limit investments to 40% of earnings and to pay out 60% of earnings to shareholders in the form of dividends.

Shareholders evaluate the companys required rate of return using the CAPM. The risk-free rate of return is 3%. The market risk premium is 6% and the firm has an equity beta of 2.

The following data table has been provided for you:

Year	Earnings	Retention Rate	Dividend	Retained Earnings	IRR	Incremental Earnings	NPV
1	150.00	0.80	30.00	120.00	0.40		200.00
2		0.80	39.60	158.40	0.30	47.52	158.40
3	245.52	0.60	98.21	147.31	0.25	36.83
4	282.35	0.40	169.41	112.94	0.15	16.94

You have been asked to do the following calculations (please give all of your answers to 2 decimal places, percentages should be entered as decimals too, eg 9.5% would be entered as 0.095):

What is the cost of equity capital demanded by shareholders?

2)

You have been given the following scenario as a company valuation case. The scenario will give you all of the relevant background to forecast earnings at time 1, and retention and IRR rates for years 1-4 as you will find in the main tutorial questions. To aid the introduction to the topic you will also be given a table showing retentions, dividends, incremental earnings and NPVs over the same period but with a number of values missing and additional information to be completed as the prep questions.

Scenario:

Savage plc is a highly profitable company that has grown rapidly in recent years. As the most profitable business locations have now been exploited its management recognises that the rate of return on further investments will tend to be lower than those the company has achieved on its investments in recent years. But while the rate of return on new investments is falling, it remains above the shareholders required rate of return. The company has financed its growth from retentions, and will continue to do so for the next few years.

It is anticipated that the companys earnings next year will be 150 million, and the company will reinvest 80% of its earnings. The company is expected to earn 40% in perpetuity on these investments. The following year the company will again reinvest the same proportion of its earnings, but the rate of return on these investments is expected to fall to 30%. Three years from now the company is expected to earn a rate of return of 25% on its investments, which will be limited to 60% of earnings. This is the last year that the company is expected to produce rate of return above the required rate of return. By year four the companys investments are expected to earn no more than 15%. From year four onwards the company is expected to limit investments to 40% of earnings and to pay out 60% of earnings to shareholders in the form of dividends.

Shareholders evaluate the companys required rate of return using the CAPM. The risk-free rate of return is 3%. The market risk premium is 6% and the firm has an equity beta of 2.

The following data table has been provided for you:

Year	Earnings	Retention Rate	Dividend	Retained Earnings	IRR	Incremental Earnings	NPV
1	150.00	0.80	30.00	120.00	0.40		200.00
2		0.80	39.60	158.40	0.30	47.52	158.40
3	245.52	0.60	98.21	147.31	0.25	36.83
4	282.35	0.40	169.41	112.94	0.15	16.94

What are the incremental earnings at time 1?

Enter your answer to 2 decimal places, percentages should be entered as decimals too, eg 9.5% would be entered as 0.095: