Question

USE THE INFORMATION BELOW FOR PROBLEMS 1-4

An analyst wishes to estimate the share price for Ashley Corporation. The following information

is made available:

Estimated profit margin = 15%

Total asset turnover = 2

Financial leverage = 1.2

Estimated dividend payout ratio = 75%

Required rate of return = 14%

Estimated EPS = $2.50

1. Calculate the firm's ROE.

2. Calculate the firm's sustainable growth rate.

3. Calculate the firm’s P/E multiple.

4. Calculate the firm’s estimated share price.

USE THE INFORMATION BELOW FOR PROBLEMS 5-8

At the end of the year 2004 the Office Equipment Industry had free cash flow to equity (FCFE)

of $2.50 per share. The following annual growth rates in FCFE are projected:

Year

Growth Rate

2005

10%

2006

15%

2007

20%

2008

25%

2009

20%

2010

15%

2011

10%

2012

7%

From year 2013 onward growth in FCFE is expected to remain constant at 5% per year. The

industry has a beta of 0.90 and the current industry price is $105. Currently the yield on 10-year

Treasury notes is 5% and the equity risk premium is 4%

5. Calculate the required rate of return on equity. (Hint: derived from CAPM)

6. Calculate the present value now (Year 2004) of FCFE during the period of increasing growth

(that is for years 2005 to 2008).

7. Calculate the present value now (Year 2004) of FCFE during the period of constant growth

(that is for years 2013 onwards).

8. Calculate the intrinsic value of the industry now (Year 2004).

Answer 1

5.

Cost of equity = 4% + (5% × 0.90)

= 4% + 4.50%

= 8.50%

Cost of equity is 8.50%.

6.

Present value during increasing growth period (year 2005 to 2008) is calculated in excel and screen shot provided below:

Present value during increasing growth period (year 2005 to 2008) is $11.62.

7.

Present value during during period of constant growth rate is caculated in excel and screen shot provided below:

Present value during during period of constant growth rate is $27.49.

8.

Terminal value at end of supernormal growth period and current stock price is caculated in excel and screen shot provided below:

Terminal value is $231.15 and current stock price is $147.85.