Question

Private Corp. is a privately held firm that builds and sells widgets globally. The business has prospered in the last few years, but the owners are afraid the growth may be slowing down. To that end, the Finance division started looking at competitors and came up with the following table:

	EPS	Dividends/Share	Stock Price	ROE	R	Debt Rating	Yield
ABC Corp.	$1.30	$0.16	$25.34	8.50%	8.00%	AA	3.15%
XYZ Inc.	$1.95	$0.23	$29.85	10.50%	13.00%	A	3.56%
Widgets Inc.	-$0.37	$0.14	$22.13	9.78%	12.00%	BBB+	4.04%
JKL Corp.	$0.50	$0.05	$28.56	9.00%	11.50%	BB+	6.12%
RTS Systems	$1:00	$0.17	$25.12	11.00%	14.00%	BB	8.02%
OAZ Technologies	$1.10	$0.18	$23.54	9.20%	10.50%	BB	7.14%
Industry Average	$0.91	$0.16	$25.76	9.66%	11.50%	-	5.34%

While gathering the data above, the Finance division noted that Widgets Inc. took an accounting write-off last year that caused the negative earnings. According to the same note, the impact of that write-off was $1.20 per share.

In the past year, Private Corp. had Earnings per Share of $3.25 and paid a total dividend of $40,000. The company is supported only by equity with no debt. There are a total of 50,000 shares outstanding. Last year the Return on Equity was 18% and the owners believe the required rate for the whole company is 15%. Private Corp's debt rating is regarded by investors as BB.

1A) Suppose the company keeps growing at the same rate. What is the value per share of the stock of Private Corp?

1B) Since the owners are skeptical the growth can remain so high going forward, they hired an external firm to perform a detailed market research concerning Private Corp's business. The conclusion from this study was that Private Corp will probably be able to grow at the current rate for about 5 years, but after that will most likely slow down to the industry average. The market research firm also concluded that the company is not as risky as the owners assume and believe the required return should be in line with the industry average required return. If the market research firm is correct, what should the stock price of Private Corp be?

**No handwritten answers. Also, please provide calculation breakdown to conceptually understand how you analyze and tackle these types of questions**

Answer 1

Answers:

Ans(1):-

Dividend per share = $40,000/ 50,000 = $0.80

Retention ratio + EPS - dividend per share ) / EPS = ($3.25 - $0.80) / $3.25 = 0.75

Growth rate = ROE * retention ratio = 18% * 0.75 = 13.5%

we know the formula,

Value per share = next year dividend / (required return - growth rate)

next year dividend = current year dividend + growth rate = $0.80 +13.5% = $0.908

Therefore,Value per share = $0.908 / (0.15 - 0.135) = $60.53

Ans(2):-

Compute the industry average growth rate

EPS of widgets Inc. need to be adjusted for one-time loss.

Adjusted EPS = -$0.37 + $1.20.

we know the formula,

Industry average growth rate = average retention ratio * average ROE

Industry average growth rate = (($1.11 - $0.16) / $1.11) * 9.66% =8.27%

To find,

value of share = present value of dividends for 5years + present value of share value at after 5years.

Share value after 5years = 6th yr dividend / (req return - growth rate)

Growth rate for five years is 13.5% , and after that it is 8.27%..Req return in the industry average of 11.50%.

Share value after 5years = ($1.33 * 1.0827) / (0.1150 - 0.0827) = $44.58

Present value of share value after 5years was = $44.58 / (1.0.1150)^5 =$29.96

Using the 11.50% discount rate ,can calculate the dividends and share value and their present values as below:

Year	Dividend	Present value
1	$0.80	$0.74
2	$0.91	$0.77
3	$1.03	$0.81
4	$1.17	$0.85
5	$1.33	$0.89
	TOTAL	$4.07

Present value of dividends = $4.07

the total value of share now = $4.07 + $29.96 = $34.03