Question
ABC Ltd. recently reported earnings-per-share of $0.75 in its financial statements for 2016, which also show shareholders equity of $250 million and total assets of
ABC Ltd. recently reported earnings-per-share of $0.75 in its financial statements for 2016, which also show shareholders equity of $250 million and total assets of $340 million. Analysts are forecasting earnings-per-share of $0.80 and $1.20 for the next two years respectively. The company has 29 million shares trading at a price of $19.00. In all of the following calculations assume a zero dividend payout ratio and a required return on the shares of 9%.
Required:
(a) Calculate residual earnings consistent with the median analyst earnings forecasts for 2017 and 2018. (3 marks)
(b) Assuming a growth rate in residual earnings of 4% after 2018, calculate the intrinsic value of the company. (3 marks)
(c) Calculate the growth rate in residual earnings after 2018 implied by the current market price. (4 marks)
(d) You have learnt that analysts forecast ABCs earnings-per-share will grow at 12% after 2018. Explain how you can use this forecast to challenge the stock price of ABC Ltd. Show all necessary calculations. (5 marks)
(e) In the context of investment decision-making, what are the advantages of using the reverse-engineering approach instead of computing the intrinsic value? (5 marks)
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