8-8 VALUING THE EQUITY OF A STABLE-GROWTH FIRM The Emerson Electric Company (EMR) was founded in 1890 and is located in St. Louis, Missouri. The firm provides product technologies and engineering services for industrial, commercial, and con- sumer markets worldwide. The firm operates in five business segments: process man- agement, industrial automation, network power, climate technologies, and appliance and tools. The company has a lengthy history of dividend payments and steady growth. In recent years, the firm's dividend payout has averaged 40% of earnings. For 2007, firm earnings were estimated to be $5.69 a share, and on December 7, 2006, Emerson's shares were trading for $86.01, and has a price-earnings ratio of 19.26. Data for the industry, sector, Emerson, and four competitor firms are shown on page 300. a. Is Emerson's current stock price reasonable in light of its sector, industry, and com- parison firms? b. Emerson's beta coefficient is 1.27. Assuming a risk-free rate of 5.02% and a mar- ket risk premium of 5%, what is your estimate of the required rate of return for Emerson's stock using the capital asset pricing model (CAPM)? What rate of growth in earnings is consistent with Emerson's policy of paying out 40% of earn- ings in dividends and the firm's historical return on equity? Using your estimated growth rate, what is the value of Emerson's shares using the Gordon (single-stage) growth model? Analyze the reasonableness of your estimated value per share using the Gordon model. c. Based on your analysis in Problem 8-8(b), what growth rate is consistent with Emerson's current share price of $86.01? Given Levered equity beta 1.27 Risk free rate (10 year US Treasury bond) 5.02% Market risk premium 5.00% Estimated earnings for 2007 Dividend payout ratio Stock price (12/07/06) 5-year growth rate estimate 5.69 0.026462039 dates 40.00% 86.01 10.00% Long-term Return on Dividend Debt to Price to Book Net Profit Price To Free Description Market Cap P/E Equity% Yield % Equity Value Margin Cash Flow Sector: Industrial Goods 16.606 14.94% 1.48% 0.87 50.471 5.40% 75.481 Industry: Industrial Equipment & Components 15.900 18.40% 1.41% 0.649 10.11 7.90% -134.900 Emerson Electric Co. $34.61B 19.276 23.72% 2.40% 0.494 4.257 9.54% 65.156 Parker-Hannifin Corp. 9.81B 14.150 18.16% 1.20% 0.308 2.298 8.25% 34.392 Roper Industries Inc. 4.44B 24.685 14.27% 0.50% 0.603 3.122 11.89% 232.735 Pentair Inc. 3.23B 17.943 11.56% 1.70% 0.485 1.974 4.48% 147.667 Walter Industries Inc. 2.19B 23.537 15.70% 0.30% 4.036 2.731 7.38% -10.682 Solution a. (Make one comment per item in answer Emerson Comparison column) to Industry P/E ROE Dividend Yield LTD to Equity Price to Book Net Profit Margin Price to Cash Flow b. Estimated cost of equity Estimated growth rate DCF Estimate of Share Price C. Imputed growth rate Impute growth rate using projected dividends using historical dividend yields Solution Legend = Value given in problem = Formula/Calculation/Analysis required = Qualitative analysis or Short answer required = Goal Seek or Solver cell Crystal Ball Input = Crystal Ball Output