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chap 5 - E5.4 Residual Earnings Valuation and Target...

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E5.4. Residual Earnings Valuation and Target Prices (Easy) This problem applies the residual earnings model and its dividend discount equivalent. Develop the pro forma as follows: 2006 2007 2008 2009 2010 2011 Eps 3.90 3.70 3.31 3.59 3.90 Dps 1.00 1.00 1.00 1.00 1.00 Bps 22.00 24.90 27.60 29.91 32.50 35.40 (a) RE (0.12) 1.26 .71 0 0 0 Discount rate 1.12 1.2544 PV 1.125 .57 Total PV 1.70 (b) Value 23.70

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(c) As residual earnings are expected to be zero after 2011, the equity is expected to be worth its book value of \$35.40. (d) The expected premium at 2011 is zero because subsequent residual income is expected to be zero. As aside: Note that 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 2008 because, at this point, expected price equals book value. = - ρ + ρ = T 1 t T T t t E 0 / TV d V The TV 2008 is given by the expected 2008 book value: TV 2008 = 27.60 So the calculation goes as follows: 2006 2007 2008 Dps 1.00 1.00 PV .89 .80 Total PV of divs. 1.69 TV 27.60 PV of TV 22.00 Value 23.69
E5.7.

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chap 5 - E5.4 Residual Earnings Valuation and Target...

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