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Question: Amanda Monaco has just inherited her fathers company. Prior to his death, Mr. Monaco was the sol...

Amanda Monaco has just inherited her fathers company. Prior to his death, Mr. Monaco was the sole stockholder, and he left the entire company to his only daughter. Although Amanda has worked for the firm for many years as a commercial artist, she does not feel qualified to manage the operation. She has considered selling the firm while it is still a viable operation and before her fathers absence causes the value of the firm to deteriorate. Amanda realizes that selling the firm will result in losing control, but her father granted her a long-term contract that guarantees employment or a generous severance package. Furthermore, if Amanda were to sell for cash, she should receive a substantial amount of money, so her financial position would be secure.

Even though Amanda would like to sell out, she has enough business sense to realize that she does not know how to place an asking price (a value) on the firm. The IRS had established a value on her fathers stock of $100 a share, and since he owned 100,000 shares, the value of the company for estate tax purposes was $10,000,000. Amanda thought that was a reasonable amount but decided to consult with Sophie Ryer, the CPA who completed the estate tax return.

Ryer suggested that the firm could be valued using a discounted cash flow method in which the current and future dividends are discounted back to the present to determine the value of the firm. She explained to Amanda that this technique, the dividend-growth model, is an important theoretical model used for the valuation of companies. In addition, she suggested that the price/earnings ratio of similar firms may be used as a guide to the value of the firm. Amanda asked Ryer to prepare a valuation of the stock based on P/E ratios and the dividend-growth model. While Amanda realized that she could get only one price, she requested range of values from an optimistic price to a mini mum, rock-bottom value.

To aid the valuation process Ryer assembled the following information. The firm earned $8.50 a share and distributed 60 percent in cash dividends during its last fiscal year. This payout ratio had been maintained for several years, with 40 percent of the earnings being retained to finance future growth.The per-share earnings for the past five years were as follows:

Year

20X1 20X2 20X3 20X4 20X5

Earnings per share

$6.70 7.40 7.85 8.20 8.50

Publicly held firms in the industry have an average P/E ratio of 12, with the highest being 17 and the lowest 9. The betas of these firms tend to be less than 1.0, with 0.85 being typical. While the firm is not publicly held, it is similar in structure to other firms in the industry. It is, however, perceptible smaller than the publicly held firms. The Treasury bill rate is currently 5.2 percent, and most financial analysts anticipate that the market as a whole will average a return of 6 to 6.5 percent greater than the Treasury bill rate.

Amanda has come to you to help devise a financial plan after the company is sold. Such a plan would encompasses the construction of a well diversified diversified portfolio with sufficient resources to meet temporary needs for cash. You do not want to blindly accept the IRS estate value of $10,000,000. Obviously, if the firm could be sold for more, that would be beneficial to your client. In addition, you want an indication of the value Ryer may place on the firm, so you resolve to answer the following questions

If the estate tax rate is 35%, what is the implication of valuation if less than $100 per share?