Question

UPS is being valued. The following assumptions have been made:
BV per share is estimated at $9.62 on 31 December 2007.
EPS will be 22 percent of the beginning BV per share for the next eight years
Cash dividends paid will be 30 percent of EPS
At the end of the eight-year period, the market price per share will be three times
book value per share at that time.
The beta for UPS is 0.60, the risk free rate is 5 percent and the equity risk
premium is 5.50 percent.
The current market price of UPS is $59.38, which indicates a current P/B of 6.2
a) Prepare a table that shows the beginning and ending book values, net income
and cash dividends annually for eight years.
b) Estimate the residual income and the present value of residual income for the
eight years.
c) Estimate the value per share of UPS stock using the residual income model.

Answer 1

a]

B]

residual income = EPS - (beginning book value * required return)

required return = risk free rate + (beta * equity risk premium) = 5% + (0.60 * 5.5%) = 8.3%

present value of each year's residual income = residual income / (1 + required return)^year

c]

Value per share = sum of all year's present value of residual income = $12.29