Question

1) WAC Railroad has a book value of $23.00 per share. The company's return on new investments (ROE) is 14 percent, and its required rate of return on equity is 12 percent. The dividend payout ratio is 60 percent. What is the value of the shares using a single-stage residual income model (to the nearest $0.01)?

$30.15 per share

$27.15 per share

$25.15 per share

$29.15 per share

None of the listed choices is correct

2) Nathan Tan valuing the Doral Corporation determines that the book value is $10.50 and the stock is trading at $14.00. Nathan estimates that Doral will earn an ROE of 20 percent over the next three years. The company is expected to payout 40 percent of earnings during this period. At the end of three years, the stock is expected to trade at two times the company’s book value. The required return is 14 percent. The intrinsic value of Doral using a multistage residual income model (to the nearest dollar) is:

$12

$40

$32

$22

None of the listed choices.

3) Giana Growers AG (GG) is currently selling at €9.8. Current EPS and current dividends per share are €1.4 and €0.9 respectively. Based on its selling price, the company’s trailing P/E is 7.0 and P/S is 0.8. The ROE is 12.0 percent, the profit margin on sales is 10 percent. The Treasury bond rate is 2 percent, the equity risk premium is 6 percent and GG’s beta is 1.2. Assuming the dividend and earnings growth rates are a constant 3 percent, the following conclusion is correct.

GG is undervalued using P/S, but overvalued using P/E

GG is overvalued using both P/E and P/S

GG is fairly-valued by both multiples.

GG is undervalued using P/E, but overvalued using P/S

GG is undervalued using both P/E and P/S

Answer 1

1. EPS (Earnings per share) = 23 * ROE

EPS = 23 * 14% = 23 * 0.14 = 3.22

Dividend per share = EPS * payout ratio

DPS = 3.22 * 0.60

= 1.932

Growth rate, g = retention ratio * RoE = (1-0.60) * 14%

g = 0.40 * 14%

g = 5.6%

Value of share = DPS/Ke - g = 1.932/12% - 5.6%

= 1.932/6.4%

= 1.932/0.064

= 30.1875

So, option a is correct.