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Question 1: (20 marks) Below are earnings per share for a firm. Year 0 earnings per share are the actual earnings per share this
Question 1: (20 marks) Below are earnings per share for a firm. Year 0 earnings per share are the actual earnings per share this year. Year 1 and 2 earnings per share are forecasts produced by an analyst. The required rate of return is 7% and the firm does not pay dividends nor will they pay dividends in the future. Required: EPS Year 0 Year 1 Year 2 4.8 5.2 5.7 a) Calculate abnormal earnings growth (AEG) for Year 2 using a pro forma. (4 marks) b) What is the long-term growth rate in abnormal earnings growth (AEG) implied by market price of $160? (4 marks) c) Using the long term implied growth rate from part (b), forecast EPS for Year 3, 4 and 5 and produce a graph of EPS growth path from year 1 to 5 with an indicator for both BUY and SELL zones. (8 marks) d) In the context of investment decision-making, what are the advantages of using the reverse-engineering approach instead of computing the intrinsic value? (4 marks)
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