Question

Your task is to estimate equity value per share for Company C.

- Earnings per share in year zero is $27.6.

- Company C pays dividends once per year at the end of each year. The next dividend will be paid one year from today.

- Retention rates and returns on investment.

   > In years 0 to 6, Company C is projected to reinvest 72% of its earnings back into the firm. The return on this investment is projected to be 14.2%.

   > In years 7 to 11, the reinvestment rate is projected to be 45% and the return on reinvested earnings is projected to be 14%.

   > Finally, in year 12 and in perpetuity, the reinvestment rate is projected to be 14% and the return on reinvested earnings is projected to be 12.1%.

   > Use the retention rates and returns to estimate earnings growth rates for each following year (that is, the retention rate in year 0 flows through to earnings growth in year 1; the retention rate in year 1 flows through to earnings growth in year 2).

- The riskiness of Company C's cash flows justifies a discount rate on equity of 11.1%.

What is your estimate of equity value per share?

A: between $261 and $265

B: between $265 and $269

C: between $269 and $273

D: between $273 and $277

E: between $277 and $281

F: answer not in this range.

Answer 1

Growth rate = Retention rate*ROE

Growth rate for years 0 to 6 = 0.72*14.2% =10.224%

Growth rate for years 7-11 = 0.45*14% = 6.3%

Growth rate for year 12 = 0.14*12.1% =1.694%

Payout ratio = 1-retention rate

Payout ratio for year 0 to 6 = 1-0.72 =0.28

Payout ratio for year 7 to 11 = 1-0.45 = 0.55

Payout ratio for year 12 = 1-0.14 = 0.86

The equity value per share is $304.86, which is not in the range given in options.