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FI516 – WEEK 4 – HOMEWORK ANSWER KEY Problem 20 - 3 20-3 a. If 100 shares are outstanding, then we have the following for Edelman: 2005 2010 Earnings per share $8,160 $12,000 Dividends per share 4,200 6,000 Book value per share 90,000 b. Using the following two equations, the growth rate for EPS and DPS can be determined. (1 + g EPS ) 5 EPS 05 = EPS 10 . (1 + g DPS ) 5 DPS 05 = DPS 10 . g EPS g DPS Kennedy 8.4% 8.4% Strasburg 6.4 6.4 Edelman 8.0 7.4 c. Based on the figures in Part A, it is obvious that Edelman’s stock would not sell in the range of $25 to $100 per share. The small number of shares outstanding has greatly inflated EPS, DPS, and book value per share. Should Edelman attempt to sell its stock based on the EPS and DPS above, it would have difficulty finding investors at the economically justified price. d. Edelman’s management would probably be wise to split the stock so that EPS, DPS, and book value were closer to those of Kennedy and Strasburg. This would bring the price of the stock into a more reasonable range. e. A 4,000-for-1 split would result in 400,000 shares outstanding. If Edelman has 400,000 shares outstanding, then we would have the following: 2005 2010 Earnings per share $2.04 $ 3.00 Dividends per share 1.05 1.50 Book value per share 22.50 f. ROE Kennedy 15.00% Strasburg 13.64 Edelman 13.33
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g. Payout Ratio 2005 2010 Kennedy 50% 50% Strasburg 50 50 Edelman 51 50 All three companies seem to be following similar dividend policies, paying out about 50% of their earnings. h. D/A is 43% for Kennedy, 37% for Strasburg, and 55% for Edelman. This suggests that Edelman is more risky, hence should sell at relatively low multiples. i. P/E Kennedy $36/$4.50 = 8.00 × Strasburg $65/$7.50 = 8.67 These ratios are not consistent with g and ROE; based on gs and ROEs, Kennedy should have the higher P/E. Probably size, listing status, and debt ratios are offsetting g and ROE. j.
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