Janice is a securities analyst specializing in firms that manufacture sugar and cement. (She analyzes information about companies and provides recommendations to her clients, who are investors, to buy, sell or hold on to equity shares in those companies.) She has just assembled some data on the dividend records of companies in the sugar industry that are listed on various stock exchanges in India.

A part of the data that she assembled is presented in the table below

Company

Current share price

Expected Dividend next year*

Expected Growth%*

ABC Industries

136

9.50

5.50%

RaiSugar and Distilleries

79

5.00

4.50%

Karumari Amman Agri Industries

113

6.25

6.0%

Jai Sugarcane Products

123

7.50

5.0%

*Based on the consensus of analysts put out by a firm that specializes in surveying analysts

Historically, Janice has noticed that the dividend discounting model works well in estimating the value of a share of enterprise in mature industries such as sugar and textiles. As such, the average of the cost of capital (i.e. market capitalization rate) for a set of comparable firms should provide an estimate of the same for any firm in the same industry.

She is valuing the shares of Katy Agro industries (Katy, hereafter), a company that operates sugar mills in four different states across the country and whose shares are listed on Indian stock exchanges. The company just resumed operations after having been shut down for close to a year due to labor unrest and other reasons.

Answer the following questions in the light of the background information given above and additional information provided as part of the respective question.

P1

What should be the cost of equity capital for Katy?

P2

Katy is expected to pay a dividend of Rs 0.50 per share a year from now, in its first year of operations after the lock-out. Once the dividend is paid, the share price of Katy is expected to decline to Rs. 28 per share. What should be the price of Katy, based on this information?

P3

The Indian Sugar Mills Association (ISMA), the apex trade body, expects the industry's earnings to grow at around 5% per annum forever. Analysts have traditionally adopted ISMA's growth estimates in valuing shares of sugar manufacturing enterprises. Assume that Katyayani will maintain a low dividend of Rs. 0.50 per share in year 1, as noted in part b above and that it will further pay dividends of Rs 1/- per share in the second year and Rs 1.50 in the third year. The dividends will grow to Rs 4 in the fourth year and thereafter (i.e. from the fifth year and subsequently) grows at the rate forecasted by ISMA. What should be the price of Katyayani's share be based on these inputs?

P-4

Assume that ISMA's growth forecasts are correct. Assume further that Katyayani has earnings per share of Rs 6 in the fourth year. What is the rate of return that the company earns on its book equity in year 5 and thereafter?