ERP is 5.5% and the Risk-Free rate is 5%. Tax is 26%

A high growth company reported Earnings per Share of $2.75 in 2000 from which it paid zero dividends. Book Value of debt $1 BN and Book Value of Equity is $3 BN. It currently pays a spread of 20bp over Treasuries on its debt. Total shares outstanding are 63 million. The current share price is $83. Its current beta is 1.25.

What is the historical PE P0/E0? 1 Mark

What is the forwards PE P0/E1? 2 Marks

What is the forwards PEG ratio? 2 Marks

Revenues, which were $4482.5 Million in 2000, and Earnings are both expected to grow at a constant rate for 5 years, during which time the company is expected to continue its policy of zero dividends.

Through both its high growth and transition phases, capex is expected to be 175% of depreciation, which in turn is expected to be 12.5% of revenue. Working capital is expected to be 10% of revenue, and the company is expected to keep the same capital structure.

In their stable phases, firms of this type are expected to have ROEs of 10%, Betas of 0.85, Debt/ Equity ratios of 50% and Pay-out ratios of 50%. Capex will be 150% of Depreciation, which in turn is expected to be 10% of revenues. WC stays at 10% of revenues.

Starting in 2006, the firm is expected to enter its transition phase, where both ROE and Beta will decline linearly towards their stable rates. This phase is expected to last from 2006 to 2015 inclusive. It will achieve stable growth in 2016.

Starting in 2006, the firm is expected to introduce a dividend equivalent to 2.5% of net income. This dividend will increase by 2.5% a year during the transition phase.

What is the current value of each share? 50 Marks

Is it a Buy/ Sell/ Hold? 1 Mark

Is the terminal growth rate calculated consistent with the risk-free rate used? Explain 3 Marks

The beta at the end is substantially lower that the starting beta, despite significantly higher leverage. Is this consistent? Explain. 5 Marks