Question

Barbara Bailey does not believe in analyst predictions. She feels that the company could maintain a constant annual growth rate in dividends per share of 6% in the future or possibly 8% for the next two years and 6% thereafter. Bailey is basing her estimates on an established long-term investment plan into the Latin American, European and Canadian Markets. By venturing into these markets the risk of the firm will increase. The company estimates that the risk premium will increase from 8.9% to 10%. Currently, the company has a risk premium of 6%.

In preparing the long-term financial plan, Bailey Clothiers' chief financial officer has assigned financial analyst, Scott Markham, to evaluate the firm's current stock price. He has asked Scott to consider the conservative predictions of the securities analysts and the aggressive predictions of Barbara Bailey.

Scott has compiled the following information from the 20X9 data to assist in his analysis:

Data: 20X9 Value

Earnings per share (E.P.S.) $ 5.25

Price per share of common stock 42.00

Book value of common stock equity $ 48,000,000

Total common shares outstanding 3,000,000

Common stock dividend per share $ 3.50

Required:

Please answer the following questions:

1. What is the company's current book value per share?
2. What is the firm's current P/E Ratio?
3. What is the current required return for Bailey Clothiers' stock?
4. What will be the new required return for Bailey Clothiers' stock assuming that they expand into the Latin American, European and Canadian markets as planned?

Answer 1

(A). Book value per share = Book value of the company / Current market price of the stock

Book value = $48,000,000

Current stock price = $42.00

So, Book value per share = $48,000,000/$42 = $11428578.14 per share

(B). Current P/E ratio = Current Market price / EPS

Current Market price = $42.00

EPS = $5.25

P/E ratio = $42.00 / $5.25 = 8

(C). Required Return = (Dividend/ Current stock price) + Dividend growth

Dividend per share = $3.50

Stock price = $42.00

Dividend Growth = 6%

Required Return = ($3.50 / $42.00) + 0.06 = 0.0834 + 0.06 = 0.1434 or 14.34%

(D) New required return after expansion of the company.

So in the above question it is given that after expansion it is expected to increase dividend growth of 8% from 6%, considering 8% growth rate the required rate of return will be as follows:

Required rate of return = (dividend / stock price) + Dividend growth rate

required return = ($3.50 / $42.00) + 0.08 = 0.0834 + 0.08 = 0.1634 or 16.34%

Hence the required rate of return for the company after the expansion will be 16.34%