Question 1 Discounted Abnormal Earnings Model Hipstone Ltd's most recent financial information, published yesterday, contained the following data: Book value of equity $250 million and Book value of debt $180 million The firm has a cost of equity of 12% and a pretax cost of debt of 6%. Earnings before interest, tax and depreciation (EBITD) are $140 million and this annual amount is expected to be constant for the next three years. Depreciation expense is constant at $20 million per year over the three years. Interest expense will also remain a constant figure over the three years. The corporate tax rate is 40 cents on the dollar A dividend of 25 cents per share is paid each year on 80 million shares outstanding Hipstone Ltd's problem is that it has a patent that expires at the end of three years from now. When the patent expires, there are several scenarios concerning the firm's horizon value, which in turn affects the fair value of a Hipstone share today. Required: Use the Discounted Abnormal Earnings valuation model to calculate the value of a Hipstone Ltd share today under these three scenarios: (1) Expected abnormal earnings from after the end of the third year are zero (10 marks) (ii) Expected abnormal earnings from after the end of the third year are expected to remain constant at the level of year three abnormal earnings. (5 marks) (iii) Hipstone Ltd's abnormal earnings from the end of the third year are expected to reduce each ensuing year by 10 percent (such that each year's abnormal earnings figure will be 90 percent of the one before it.)