QUESTION 3 Valuing Stocks 20 marks Your CFO has sent you three analyst reports for a young, growing company that you are interested in acquiring These reports depict the company as speculative, but each one poses different projections of the companys future growth rate in earnings and dividends All three reports show that the company recorded an earnings per share (EPS) of $1 20 The company just paid 40 of its earnings as dividends Theres consensus that market rate of return (expected rate of return) to investors for this share is 14 percent, and that companys management expects to consistently earn a 15 percent return on equity (ROE 15 percent) REPORT A The analyst who produced report A makes the assumption that the company will remain a small, regional company that, although profitable, is not expected to grow Therefore, the company expects to pay the same dividend per share in future years Based on this report, what model can you use to value a share in the company Using this model, what is the value of a share REPORT B The analyst who produced report B makes the assumption that the company will enter the national market and grow at a constant rate i e at the companys current sustainable growth rate Based on this report, what model can you use to value a share in the company Using this model, what is the value of a share REPORT C The analyst who produced report C also makes the assumption that the company will enter the national market but expects a high level of initial excitement for the product that is then followed by growth at a constant rate Earnings and dividends are expected to grow at a rate of 50 percent over the next year (i e year 1), 20 percent for the following two years (year 2 and year 3), and then revert back to the companys constant growth rate which is the companys current sustainable growth rate Based on this report, what model can you use to value a share in the company Using this model, what is the value of a share Comment on the different valuations you have just done

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Posted on Oct 05, 2024

QUESTION 3 Valuing Stocks 20 marks Your CFO has sent you three analyst reports for a young, growing company that you are interested in acquiring.

QUESTION 3 Valuing Stocks 20 marks

Your CFO has sent you three analyst reports for a young, growing company that you are interested in acquiring. These reports depict the company as speculative, but each one poses different projections of the companys future growth rate in earnings and dividends. All three reports show that the company recorded an earnings per share (EPS) of $1.20. The company just paid 40% of its earnings as dividends. Theres consensus that market rate of return (expected rate of return) to investors for this share is 14 percent, and that companys management expects to consistently earn a 15 percent return on equity (ROE = 15 percent).

REPORT A

The analyst who produced report A makes the assumption that the company will remain a small, regional company that, although profitable, is not expected to grow. Therefore, the company expects to pay the same dividend per share in future years.

Based on this report, what model can you use to value a share in the company? Using this model, what is the value of a share?

REPORT B

The analyst who produced report B makes the assumption that the company will enter the national market and grow at a constant rate i.e. at the companys current sustainable growth rate.

Based on this report, what model can you use to value a share in the company? Using this model, what is the value of a share?

REPORT C

The analyst who produced report C also makes the assumption that the company will enter the national market but expects a high level of initial excitement for the product that is then followed by growth at a constant rate.

Earnings and dividends are expected to grow at a rate of 50 percent over the next year (i.e. year 1), 20 percent for the following two years (year 2 and year 3), and then revert back to the companys constant growth rate which is the companys current sustainable growth rate.