Question

Riskfree rate = 0.016                             Market rate = 0.078

Using the information below and the CD&E model, forecast Carlisle’s cash flows for t+1, t+2, and t+3 to determine whether Carlisle is over or under valued if it’s trading at $123.68.

	t	t-1	t-2	t-3
EPS	$9.05
DPO		0.23	0.22	0.26
ROE		0.17
Beta	1.95
P/E		18.7	18.7	17.2

Answer 1

> Formula

As per CAPM

• K(e) = Rf + (Rm - Rf) * Beta

where, Rf = Risk Free rate

            Rm = Marker return

• PE ratio = Price per share / Earnings per share
• Growth rate = Retention Ratio * Return on equity

• Market price of share = D1 / (1+ ke) + D2 / (1+ ke)2 + D3 / (1+ ke)3 + P3 / (1+ ke)3

                                         

> Calculation

• K(e) = 0.016 + ( 0.078 - 0.016) * 1.95  

                 = 0.1369 or 13.69% Answer

• Growth Rates

Growth year 1 (g1) = 0.23 * 0.17

                    = 0.0391

Growth year 2 (g2) = 0.22 * 0.17

                    = 0.0374

Growth year 3 (g3) = 0.26 * 0.17

                    = 0.0442

• Dividend

Dividend 1 = 9.05 * 1.0391 * 0.23

               = 2.1627

Dividend 2 = 9.05 * 1.0391 * 1.0374 * 0.22

                = 2.1462

Dividend 3 = 9.05 * 1.0391 * 1.0374 * 1.0442 * 0.26

                = 2.6486

• EPS 3 = 9.05 * ( 1 + g1) * ( 1 + g2) * ( 1 + g3)

                    = 9.05 * ( 1.0391) * (1.0374) * ( 1.0442 )

                    = 10.1868

• Price year 3 = EPS3 * PE ratio 3

                           = 17.2 * 10.1868

                           = 175.21

• Market price today   = D1 / (1+ ke) + D2 / (1+ ke)2 + D3 / (1+ ke)3 + P3 / (1+ ke)3       

                                        = 2.1627 / (1.1369) + 2.1462 / (1.1369)2 + 2.6486 / (1.1369)3 + 175.21 / (1.1369)3

                                        = $ 124.60 Answer

Hope you understand the solution.