Question

Mercadolibre is an Argentinian based online shopping platform partially owned by Amazon. The company has had moderate success growing their topline at a steady rate of 30% while maintaining 18.5% net margins that they expect to maintain for the next three years. In year 4, residual income is expected to grow at 7.2% indefinitely. In FY 2018 they generated ARP 25,458,900,000 in revenue while their balance sheet showed that they had ARP 96,236,000,000 in assets while also having ARP 53,987,120,000 in liabilities. The company maintains a dividend policy of 4.2%. The required return on equity is 13.65%. (5 pts for each subsections)       

What is the initial Book Value of Mercadolibre?

What is the residual income in 2019?

What is the value of the company in 2018?

What would be a problem with using the residual income model for Mercadolibre?

Answer 1

Answer )

As per accounting equation

Asset = Liability + equity + Revenue

Residual income = Net Income ? Equity Charge.

Equity Charge = Equity Capital x Cost of Equity,

As per data of year 2018 ,

=> Equity = Asset - (liability +revenue) = APR 16789980000

=> Equity Charges = 16789980000 * 13.65% = APR 2291832270

=> Residual Income (RI)= APR 23167067730

FOR 2019

The Residual Income = RI₂₀₁₈ (1+ growth rate) = APR 24835096606.56

Valuation using residual model

Here , Assumption , as start date of company not given , I assume that the 2018 was the first year of having RI and r = 13.65%

V₂₀₁₈ = APR 16789980000 + ( APR 23167067730 / ( 1+13.65%)) = APR 37174553453.5856

As Clearly observed , the RI model is similar to the dividend discount model (DDM) , substituting RI at place of dividend payments and the cost of equity for at place of 'r'.

The RI approach will be most appropriate for firm not paying any dividends. Further, value is recognized earlier and less sensitive to terminal value.

The one part of question ,What is the initial Book Value of Mercadolibre? , required date of start of business firm for exact calculation , if my assumption of start date is right in above senction , kindly put in comment . I'll provie the solution of the sub-section