Question 2

(i) Baggai Enterprises has an ROA of 10 percent, retains 30 percent of earnings, and has an equity multiplier of 1.25. Mondale Enterprises also has an ROA of 10 percent, but it retains two-thirds of earnings and has an equity multiplier of 2.00.

a. What are the sustainable dividend growth rates for (A) Baggai Enterprises and (B)

Mondale Enterprises?

b. Identify the drivers of the difference in the sustainable growth rates of Baggai Enterprises and Mondale Enterprises.

question 2(ii)

Toyota Motor Corporation (TYO: 7203; NYSE: TM) is one of the worlds largest vehicle manufacturers. The companys most recent fiscal year ended on 31 March 2008. In early May 2008, you are valuing Toyota stock, which closed at 5,480 on the previous day. You have used a free cash flow to equity (FCFE) model to value the company stock and have obtained a value of 6,122 for the stock. For ease of communication, you want to express your valuation in terms of a forward P/E based on your forecasted fiscal year 2009 EPS of 580. Toyotas fiscal year 2009 is from April 2008 through March 2009.

a. What is Toyotas justified P/E based on forecasted fundamentals?

b. Based on a comparison of the current price of 5,480 with your estimated intrinsic value of 6,122, the stock appears to be slightly undervalued. Use your answer to question 1 to state this evaluation in terms of P/Es.

Question 2 (iii)

Joel Williams follows Sonoco Products Company (NYSE: SON), a manufacturer of paper and plastic packaging for both consumer and industrial use. SON appears to have a dividend policy of recognizing sustainable increases in the level of earnings with increases in dividends, keeping the dividend payout ratio within a range of 40 percent to 60 percent. Williams also notes: SONs most recent quarterly dividend (ex-dividend date: 15 August 2007) was $0.26, consistent with a current annual dividend of 4x $0.26 =$1.04 per year. SONs forecasted dividend growth rate is 6.0 percent per year. With a beta of 1.13, given an equity risk premium (expected excess return of equities over the risk-free rate, E [RM] RF) of 4.5 percent and a risk-free rate (RF)of 5 percent, SONs required return on equity is r= RF + beta[E(RM) RF]=5.0+1.13(4.5)₌10.1 percent, using the capital asset pricing model (CAPM).

Williams believes the Gordon growth model may be an appropriate model for valuing SON.

a. Calculate the Gordon growth model value for SON stock.

b. The current market price of SON stock is $30.18. Using your answer to question 1, judge whether SON stock is fairly valued, undervalued, or overvalued.