The management of Telluride, an international diversified conglomerate based in the United States, believes that the recent strong performance of its wholly owned medical supply subsidiary, Sundanci, has gone unnoticed. To realize Sundancis full value, Telluride has announced that it will divest Sundanci in a tax-free spin-off.

Sue Carroll, CFA, is director of research at Kesson and Associates. In developing an investment recommendation for Sundanci, Carroll has gathered the information shown in exhibits 1 and 2 below:

Exhibit 1 Sundanci Actual 2007 and 2008 Financial Statements for Fiscal Years ending 31 May

(dollars in millions except per share data)

Income Statement			2007		2008
Revenue			474		598
Depreciation			20		23
Other operating costs			368		460
Income before taxes			86		115
Taxes			26		35
Net Income			60		80
Dividends			18		24
EPS			0.714		0.952
Dividends per share			0.214		0.286
Common shares outstanding Balance Sheet			84.0		84.0
Current assets (includes $5 cash in 2007 and 2008)			201		326
Net property, plant and equipment			474		489
Total assets			675		815
Current liabilities (all non-interest bearing)			57		141
Long-term debt			0		0
Total liabilities			57		141
Shareholders equity			618		674
Total liabilities and equity			675		815
Capital expenditures Exhibit 2: Selected Financial Information			34		38
Required rate of return on equity	14%
Industry growth rate	13%
Industry P/E	26

You have been directed by Carroll to determine the value of Sundancis stock by using the FCFE model. You believe that Sundancis FCFE will grow at 27% for two years and at 13% thereafter. Capital expenditures, depreciation, and working capital are all expected to increase proportionately with FCFE.

a.Calculate the amount of FCFE per share for 2008 by using the data from exhibit 1.

b.Calculate the current value of a share of Sundanci stock based on the two-stage FCFE model

c.Describe limitations that the two-stage DDM and FCFE models have in common.