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Question 4
An analyst presents you with the following pro forma (in millions of dollars) that
gives her forecast of earnings and dividends for 2013-2017. She asks you to value
the 1,380 million shares outstanding at the end of 2012, when common
shareholders' equity stood at $4,310 million. Use a required return for equity of 10
percent in your calculations.
completed pro forma above. Book value each year is the prior book value
plus earnings and minus dividends for the year. So, for 2014 for example,
The starting book value (in 2012) is 4,310. Residual earnings for each year
is earnings charged with the required return in book value. So, for 2014,
c. The growth rate in residual earnings is 5% after 2015. Assuming this growth
rate will continue into the future, the valuation is a Case 3 valuation with the
PV 1.125 .57
Total PV 1.70
(b) Value 23.70
(c) As residual earnings are expected to be zero after 2017, the equity is expected to be
An aside: The calculation can also be made by forecasting the cum-dividend book value
in 2017 and reducing it by the value of dividends to be paid out (to get an ex-dividend
price):
(d) The expected premium at 2017E is zero because subsequent residual income
is expected to be zero. Knowing this, you can calculate the expected price at 2017E
as equal to the expected book value at that date: $35.42. This is a much shorter
calculation!
(e) The dividend discount formula can be applied because we now have a basis
for calculating its terminal value. The terminal value is the expected terminal price,
and this can be calculated at the end of 2014E because, at this point, expected price
V0 t d t TVT / T
E
t1
TV2002 = 27.60
Note that, as price is expected to equal book value at the end of 2014E, then we can
also get the current value by taking the present value of the cum-dividend terminal book
value:
As
and as
then
PV = 29.72/1.122 = 23.69