question 6

Same facts as Q4 in photos attached, except derive the value of the firm and the price per common share using the earnings-based valuation model.

1. Compute residual income for the next 5 years, and verify that residual income is growing at a constant rate after year 3. What is that rate?
2. Use the residual income (abnormal earnings) model to derive derive the value of the company and the price per common share. Compare your answer to the answer you got using the free cash flow to equity investors (dividend discount model) in (4) above.
3. Define the concept of residual income (abnormal earnings).
4. Explain why positive (negative residual income in all future periods causes price-to-book ratios greater (less) than one

See your computation of residual income in (a) above and notice the eftect of positive and

negative values added to the book value of common equity in the computation ot value in (b)

anove

In this example, what is the company's P/B ratio? Why is it greater or less than 1.0?

Quesuion I. Assume you expect a company's net income to remain stable at $2,000 for all future ycars, and you expect all earmings to be distributed to stockholders at the end of each year, so that common equity also remains stable for all future years (assumes clean sarplus). Also, assume the company's =1,5, the market risk premium is 6% and the 20-year yield on risk free treasury bonds is 2%. Finally, assume the company has 1,000 shares of common stock outstanding. a. Use the CAPM to estimate the compuny's equity cost of capital. b. Compute the expected net distributions to stockholders (drvidends) for each future year. c. Use the dividend discount (i.e., free cash flow to equity imvestors) valuation model to estimate the company"s current stock price. Question 2. Use the same facts as in QI above, but assume you expest the company's income to be $2,000 in the coming year and to grow at the rate of 5% in every subsequent year into infinity. Also, assume that the company's common equity as of the end of the most recent fiscal year is 512,000 , and the investment needed to support the growth in net income causes sharcholders' equity to increase by 5% cach year. Assume the company is an all-equity firm: i.e., all financing comes from stockholders and nooe comes for debtholders. In this case, the company's balance sheet has net operating assets (NOA) of 512.000 , shareholders' oquity of $12,000, and zero net financial obligations (ie zero net debt). a. Compute dividends (or free cash flow to equityholders) for the coming year and the rate of a. Compute the dividend payment for the next three year, and then dividends for all future years. b. Use the dividend discount (i.e., free cash flow to equity investors) valuation model to estimate the company's current stock price. Question 4. Same facts as Q3 above, except the growth rates for income and beginning of year shareholders' equity are 5% for years 2 and 3 and then 3% perpetually for all future years. a. Compute dividends for the next three years and then growth in dividends for all future years. b. Use the dividend discount (i.e., free cash flow to equity investors) valuation model to estimate the company's current stock price