Q1) Firm ABC is forecasting EPS of Rs 3.30 next year.

Its investors require a return of 15%

a) What is the no-growth value of ABC’s stock?

b) If the stock’s price is currently Rs 30, what is the present value of growth opportunities?

c) What is the implied P/E ratio for the stock?

Ans.

a) Value of Stock = Forecasted EPS/required rate of return

Value of Stock (INR) = 22.00

b) Value of Stock = Current price - value of Stock

Value of Stock (INR) = 8.00

c) P/E Ratio = Market Price / EPS

P/E Ratio = 9.09

Q2. Your client is planning to purchase a stock that doesn't pay dividend in the next two years. In
the third year the stock will pay a dividend of Rs 10. This dividend will grow at 50% per annum for
the next three years. From then onwards the perpetual growth rate will stabilize to -1.00 % (minus
one percent) per annum. At 10% cost of equity of what will be the intrinsic value of this stock.

Ans.

PV = Value of Explicit Forecasted period + Value of Perpetual growth rate

PV = 50.78 + 171.46

Intrinsic Value of Stock = INR 222.24

Value of Explicit Forecasted period

 Yea PV@10
r Dividend %

1 - -

2 - -

3 10.00 7.51

4 15.00 10.25

5 22.50 13.97

6 33.75 19.05

Total 50.78

Value of Perpetual growth rate

Particulars Amount

Dividend 33.41
Growth rate -1%
Cost of equity 10%
   

Ph 303.75
   

ph / (1.1)^6 171.46

Formula used:

Q3. The Bell Weather Co. is a new firm in a rapidly growing industry and has just paid its annual
dividend of Rs.1.00 per share. Dividends are expected to grow 20% a year for the next four years
and then at the rate of 5% per year forever. What is the current value of one share if the required
rate of return is 10%?

Ans.

PV = Value of Explicit Forecasted period + Value of Perpetual growth rate

PV = 5.00 + 29.74
Intrinsic Value of Stock = INR 34.74

Value of Explicit Forecasted period

Year Dividend PV@10%

0 1.00 1.00

1 1.20 1.09

2 1.44 1.19

3 1.73 1.30

4 2.07 1.42
  Total 5.00

Value of Perpetual growth rate

Particulars Amount

Dividend 2.18
Growth Rate 5%
Cost of equity 10%
   

Ph 43.55
   

ph / (1.1)^4 29.74

Formula used:

Q4. Nu-Tek, Inc. just paid a dividend of Rs.1.80 per share. The firm is expecting a period of intense
growth and has decided to retain more of its earnings to help finance that growth. As a result, it is
going to reduce its annual dividend by 10% a year for the next three years. After that, it will
maintain a constant dividend of Rs. 0.70 a share. What is the value of this stock if the required rate
of return is 13%?

Ans.

PV = Value of Explicit Forecasted period + Value of Perpetual growth rate

PV = 3.48 + 3.73

Intrinsic Value of Stock = INR 7.22

 Value of Explicit Forecasted period
Year Dividend PV@13%

0 1.80 1.80

1 1.62 1.43

2 1.46 1.14

3 1.31 0.91
Total 3.48

Value of Perpetual growth rate

Particulars Amount
Dividend 0.70
Growth Rate 0%
Cost of equity 13%
   
Ph 5.38
   
ph / (1.13)^3 3.73

Formula used:

Q5. ABC is a young start up company. No dividends are paid on the stock over the next nine years,
because the firm needs to flow back its earnings to fuel growth. The company will pay its first
dividend of Rs 15 per share dividend in the 10th year and will increase the dividend by 5.5% per
year thereafter. If the required rate of return on this stock is 13%, what is the current share price?

Ans.

PV = Value of Explicit Forecasted period + Value of Perpetual growth rate

PV = 4.42 + 61.89

Intrinsic Value of Stock = INR 66.31

Value of Explicit Forecasted period

Yea
r Dividend PV@13%
10 4.42
 15.00
Total 4.42

Value of Perpetual growth rate

Particulars Amount

Dividend 15.76

Growth Rate 5.5%

Cost of equity 13%

   

Ph 210.10
   

ph / (1.13)^10 61.89

Formula used:

Q6. A company is growing quickly. Dividends are expected to grow at a rate of 20% for the next
three years, with the growth rate falling off to a constant 5% thereafter. If the required rate of
return is 12% and the company just paid a Rs 2.80 dividend, what is the current share price?

Ans.

PV = Value of Explicit Forecasted period + Value of Perpetual growth rate

PV = 9.66 + 51.66

Intrinsic Value of Stock = INR 61.32

Value of Explicit Forecasted period

Yea
r Dividend PV@12%

0 2.80 2.80

1 3.36 3.00

2 4.03 3.21

3 4.84 3.44
Total 9.66
 Value of Perpetual growth rate
Particulars Amount

Dividend 5.08
Growth Rate 5%
Cost of equity 12%
   

Ph 72.58
   

ph / (1.12)^3 51.66

Formula used:

Q7. A company is experiencing rapid growth. Dividends are expected to grow at 30% during the
next three years, 18% over the following year, and then 8% per year indefinitely. The required
return on the stock is 11%, and the stock currently sells for Rs 65 per share. What is the projected
dividend for the coming year?

Ans.

65 = Value of Explicit Forecasted period + Value of Perpetual growth rate

65 = 5.86X + 61.48X

X = 0.965

Dividend for coming year = 0.965*1.3 = INR 1.25

Let the dividend declared in current year be X

Value of Perpetual
Value of Explicit Forecasted period growth rate
Growth
Amount
Year rate Dividend PV@11% Particulars
1 30% 1.3X 1.17X Dividend 2.80
2 30% 1.69X 1.37X Growth Rate 8%
3 30% 2.197X 1.61X Cost of equity 11%
4 18% 2.59246X 1.71X    
Total 5.86X Ph 93.33
    
ph / (1.11)^4 61.48

Formula used:

8. You have found the following stock quote for RJW company in today’s newspaper. What is the
annual dividend? What was the closing price for this stock yesterday? If the company currently has
25 million shares of stock outstanding, what is the net income last year?

Ans:

Closing price for yesterday = Today’s closing price + Net price change since yesterday
= 26.18 - (-.13)

= 26.31

Annual Dividend per share = Stock price * Dividend yield %

= 26.18*1.9%

= 0.497

Income per share (EPS) = Market Price per share/PE ratio

= 26.18/23

= 1.138

Net income of Company = Shares outstanding*EPS

= 25 Million*1.138

= 28.45 Million

Q9. ABC co. earned 18 million for the fiscal year ending yesterday. The pay-out ratio of the firm is
30%. The firm will continue to pay 30% of its earnings as annual, end-of-year dividends. The
remaining 70% of earnings is retained by the company for use in projects. The company has 2
million shares of common stock outstanding. The current stock price is Rs 93. The historical return
ROE of 13% is expected to continue in the future. What is the required rate of return on the stock?

Ans.

g = Retention Ratio x Return on retained earnings

g = 70%*13%

g = 9.1%

EPS for the current year = Earnings / No. of outstanding shares

 = 18 Million / 2 Million

= 9 per share

Dividend for the coming year = EPS for the current year*g*Payout ratio

= 9*(1.091) *30%

= 2.9457

Here, D1 = 2.9457

g = 9.1%

R = 12.267%

10. The Yurdone Corporation wants to setup a private cemetery business. According to the CFO,
Barrry M. Deep, business is “looking up.” As a result, the cemetery project will provide a net cash
inflow of $290,000 for the firm during the first year, and the cash flows are projected to grow at a
rate of 5 percent per year forever. The project requires an initial investment of $3,900,000.

a) If Yurdone requires a return of 11 percent on such undertakings, should the cemetery business
be started?

b) The company is somewhat unsure about the assumption of a growth rate of 5 percent in its
cash flows. At what constant growth rate would the company just break even if it still required a
return of 11 percent on investment?

Ans.

a) The project should be started if its NPV is positive

NPV = PV of future cash flows - Initial investment

NPV = [2,90,000/(11%-5%)] - 3900000

NPV = $9,33,333

The Cemetry Business should be started

b) 0 = [2,90,000/(11%-g%)] - 3900000

g = 3.56410%

Formula Used: