Exercise #3

Exercise #3 - Finance 351 Financial Management Instructor...

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1 Finance 351: Financial Management Instructor: Shuming Liu In-Class Exercise 3 Solution to Minicase for Chapter 7 The goal is to value the company under both investment plans. The discount rate is the 11% that investors believe they can earn on similar-risk investments, not the 15% return on book equity. Return on equity is useful, however, for computing the growth rate of dividends under the past growth scenario. Starting in 2013, in the past growth scenario, two-thirds of earnings will be paid out as dividends, and one-third will be reinvested. Therefore, the sustainable growth rate as of 2013 is: return on equity × plowback ratio = 15% × 1/3 = 5% Valuation based on past growth scenario: The firm has been growing at 5% per year. Dividends are proportional to book value and have grown at 5% annually. Dividends paid in the most recent year (2012) were $7.7 million and are projected to be $8 million next year, in 2013. The value of the firm is therefore: 33 . 133 $ 0.05 - 0.11 million
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