Problem 1

On January 1, 1991, you are considering the purchase of ABC Company's common share. You have collected the following information on ABC Company:

1. Book value for common share on January 1, 1991 is $12 per share.

2. Predicted net income for 1991 is $2 per share and net income is expected to increase by 10% every year until 1995.

3. ABC is expected to pay $0.2 dividends per year from 1991 to 1995.

4. After 1995, abnormal earnings will grow by 5% per year.

5. ABC's beta is estimated to be 1.2. The risk-free rate of return is estimated to be 6.6% and the market risk premium is 7%. You should use the CAPM model to estimate the equity cost of capital for ABC Company.

Required: Using the abnormal earnings formula, compute the estimated equity value per share of ABC Company on January 1, 1991. Your answers must show the steps of computations for any credits