Question

AFW Industries has 184 million shares outstanding and expects earnings at the end of this year of $ 658 million. AFW plans to pay out 56 % of its earnings in total, paying 32 % as a dividend and using 24 % to repurchase shares. If AFW's earnings are expected to grow by 8.2 % per year and these payout rates remain constant, determine AFW's share price assuming an equity cost of capital of 11.7 %.

Answer 1

In this context, the company pays out money in two ways, one by paying out cash dividends and second by stock repurchases. Share repurchases impact share prices only temporarily, however, as AFW plans on continuing repurchases presumably indefinitely, the same activity would permanently impact the company's stock price.

Assuming that today is current time with t=0, expected earnings next year at t =1 is $ 658 million

Total Payout = 56% of earnings with dividends constituting 32% of the aforementioned payout amount and the remaining being share repurchase proceeds.

Expected Dividend Payout next year (at t=1) = 0.32 x 658 = $ 210.56 million

Expected Repurchase Payout next year (at t = 1) = 0.24 x 658 = $ 157.92 million

Expected earnings growth rate is 8.2 % per year and payout ratios/proportions will remain constant, thereby implying a constant growth rate of 8.2% in both dividend and repurchase payouts.

Therefore, Dividend Growth Rate = g = 8.2 % and Equity Cost of Capital = R = 11.7%

Using the perpetual constant growth cash flow discount model we get equity value V(e) through the following relationship:

V(e) = 368.48 / (R-g) = 368.48 / (0.117 - 0.082) = $ 10528 million

Number of outstanding shares = N = 184 million

Price per share = P0 = V(e) / N = 10528 / 184 = $ 57.2173 or $ 57.22 approximately.