In: Finance
reverse engineering with abnormal earnings growth model (chapter 7 problem 5E) - analysts forecast forward earnings of $2.11 per share and a forecast of $2.67 for 2 years ahead. The firm pays no dividends. the required return is 9%.
what is the long term growth rate in abnormal earnings growth (AEG) implied by a market price of $105.69?
what is the market's forecast of EPS for 3 years ahead.
as I stated earlier - this problem does not have the answer listed in the textbook answers portion of chegg. I have paid for this service and would like to have the solution to this problem. thank you
Answer :
Given Data:
EPS = Earnings per Share
1st Year $ 2.11
2nd Year $ 2.67
Required Rate of Return = 9%
Dividend = no dividend payment , Hence DPS = 0
what is the long term growth rate in abnormal earnings growth (AEG) implied by a market price of $105.69?
P = 1/r + ( Earnings at year2 + (Abnormal Earnings / r - g) )
Here,
p = Market Price
r = required rate of return
g = growth rate
Here,
Abnormal earnings are calculated as follows :
Particulars | Year 1 | Year 2 |
Earnings per share | $ 2.11 | $ 2.67 |
Dividend Paid | 0 | 0 |
Dividend reinvested at rate 9% | 0 | |
Total Earnings | $ 2.67 | |
Less : Normal EPS ( 2.11 x 1.09) | $ 2.30 | |
Abnormal Earnings | $ 0.37 |
Hence, P = 1/r x ( Earnings at year2 + (Abnormal Earnings / r - g) )
$105.69 = 1/0.09 x ( $ 2.67 + ( $0.37 / 1.09 - g )
9.5121 = 2.67 + ( $0.37 / 1.09 - g )
6.8421=( $0.37 / 1.09 - g )
1.09 - g = 0.5408
g = 1.0359
It means long term growth rate in abnormal earnings growth (AEG) implied is 3.59%
what is the market's forecast of EPS for 3 years ahead?
= Normal EPS at Year 2 grows at normal rate of return + Abnormal Earnings
= $ 2.67 x 1.09 + ( $ 2.67 x 3.59%)
= $ 2.91 + $ 0.0959
= $ 3.0062