Question

Benchmark Metrics Inc.​ (BMI), an​ all-equity financed​ firm, reported EPS of $4.14 in 2008. Despite the economic​ downturn, BMI is confident regarding its current investment opportunities. But due to the financial​ crisis, BMI does not wish to fund these investments externally. The Board has therefore decided to suspend its stock repurchase plan and cut its dividend to $0.65 per share​ (vs. almost $2 per share in​ 2007), and retain these funds instead. The firm has just paid the 2008​ dividend, and BMI plans to keep its dividend at $0.65 per share in 2009 as well. In subsequent​ years, it expects its growth opportunities to​ slow, and it will still be able to fund its growth internally with a target 36%

dividend payout​ ratio, and reinitiating its stock repurchase plan for a total payout rate of 60%.​(All dividends and repurchases occur at the end of each​ year.)

Suppose​ BMI's existing operations will continue to generate the current level of earnings per share in the future. Assume further that the return on new investment is 15%​,

and that reinvestments will account for all future earnings growth​ (if any).​ Finally, assume​ BMI's equity cost of capital is 10%.

Hint​:

Make sure to round all intermediate calculations to at least four decimal places.​  

a. Estimate​ BMI's EPS in 2009 and 2010​ (before any share​ repurchases).

​BMI's EPS in 2009 is $.............​(Round to the nearest​ cent.)

​BMI's EPS in 2010 is​$..........(Round to the nearest​ cent.)

b. What is the value of a share of BMI at the start of 2009​ (end of​ 2008)?

The value of a share of BMI at the start of 2009 is ​$..............​(Round to the nearest​ cent.)

Answer 1

Solution:-

To Calculate EPS in 2009-

First we need to calculate Retention Ratio-

Retention Ratio =

Retention Ratio =

Retention Ratio = 84.30%

Then Calculate Earnings Growth rate -

Earning Growth Rate = Retention Rate * Return on New Investment

Earning Growth Rate = 0.8430 * 0.15

Earning Growth Rate = 12.645%

EPS in 2009-

To Calculate EPS in 2010-

Retention Rate =

Retention Rate = 86.06%

Then Calculate Earnings Growth rate -

Earning Growth Rate = Retention Rate * Return on New Investment

Earning Growth Rate = 0.8606 * 0.15

Earning Growth Rate = 12.909%

EPS in 2010-

B. To Calculate Share Value at the beginning of Year 2009-

First we need to calculate Growth Rate -

Total Payout Ratio = 60% (Given in Question)

Retention Ratio = 1 - Payout Ratio

Retention Ratio = 1 - 0.60

Retention Ratio = 40%

Growth Rate = Retention Ratio * ROIN

Growth Rate = 0.40 * 15%

Growth Rate = 6%

Share Value at the beginning of Year 2009 is $79.

To Calculate Share Value at the start of Year 2009-

Share Value at the start of Year 2009 is $72.41

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