In the problems following, use an equity risk premium of 5.5 percent if none is specified.

1. National City Corporation, a bank holding company, reported earnings per share of $2.40 in 1993, and paid dividends per share of $1.06. The earnings had grown 7.5% a year over the prior five years, and were expected to grow 6% a year in the long term (starting in 1994). The stock had a beta of 1.05 and traded for 10 times earnings. The Treasury bond rate was 7%, and the risk premium is 5.5%.

a. Estimate the PE ratio for National City Corporation.

b. What long-term growth rate is implied in the firms current PE ratio?

2. NCH Corporation, which markets cleaning chemicals, insecticides, and other products, paid dividends of $2 per share in 1993 on earnings of $4 per share. The book value of equity per share was $40, and earnings were expected to grow 6% a year in the long term. The stock had a beta of 0.85, and was selling for $60 per share. (The Treasury bond rate was 7%, and the market risk premium was 5.5%.)

a. Based on these inputs, estimate the pricebook value ratio for NCH.

b. How much would the return on equity have to increase to justify the pricebook value ratio at which NCH was selling for in 1993?

3. Walgreen, a large retail drugstore chain in the United States, reported net income of $221 million in 1993 on revenues of $8,298 million. It paid out 31% of its earnings as dividends, a payout ratio it was expected to maintain between 1994 and 1998, during which period earnings growth was expected to be 13.5%. After 1998, earnings growth was expected to decline to 6%, and the dividend payout ratio was expected to increase to 60%. The beta was 1.15 and was expected to remain unchanged. The Treasury bond rate was 7%, and the risk premium was 5.5%.

a. Estimate the price/sales ratio for Walgreens, assuming its profit margin re- mains unchanged at 1993 levels.

b. How much of this price/sales ratio can be attributed to extraordinary growth?

4. You have been asked to assess the value per share of Secure Savings, a mature savings and loan company. The company had earnings per share in the just-completed financial year of $4 per share and paid dividends of $2.40 per share. The book value of equity at the beginning of the year was $40 per share. The beta for the stock is 0.90, the risk-free rate is 6%, and the market risk premium is 4%.

a. Assuming that the firm will continue to earn its current return on equity in perpetuity and maintain its current dividend payout ratio, estimate the value per share.

b. If the stock is trading at $40 a share, estimate the implied growth rate.

5. Toro Corporation, which manufactures lawn mowers and tractors, had revenues

of $635 million in 1992, on which it reported a loss of $7 million (largely as a consequence of the recession). It had interest expenses of $17 million in 1992, and its bonds were rated BBB; a typical BBB-rated company had an interest coverage ratio (EBIT/interest expenses) of 3.10. The company faced a 40% tax rate. The stock had a beta of 1.10. (The Treasury bond rate was 7%, and the risk premium is 5.5%.)

Toro spent $25 million on capital expenditures in 1992, and had depreciation of $20 million. Working capital amounted to 25% of sales. The company expected to maintain a debt ratio of 25%. In the long term, growth in revenues and profits was expected to be 4%, once earnings return to normal levels.

a. Assuming that the bond rating reflects normalized earnings, estimate the normalized earnings for Toro Corporation.

b. Allowing for the long-term growth rate on normalized earnings, estimate the value of equity for Toro Corporation.