Reference no: EM132590719

Question - A firm has a policy of paying out all of its earnings as dividends It's earnings and dividends per share are both expected to grow indefinitely by 4% per year. Its cost of equity capital is 6%. It is an all equity (i.e. no debt) firm.

a) If next year's earnings are $8 per share, what should the firm's share price be?

b) Using the same facts as 3a), but now assume that the earnings and dividend will grow at the rate of 3% per year forever. What should the firm's share price be?

c) Now assume that at the end of the most recent financial year our firm has shareholders' equity of $48 per share, and that the investment in property plant and equipment and inventory) needed to support the growth in earnings means that shareholders' equity will also grow by 3% per year indefinitely.

i) Calculate the dividends for the next year, and the percentage growth in dividends for each year after that.

ii) Use the discounted dividend valuation model to estimate the company's current share price.

d) i) Use the facts in 3c) above and calculate residual income for the next three years.

ii) Calculate the percentage increase in the growth rate in residual income for the next three years (ie years 2 and 3).

iii) Use the residual income valuation model to estimate the value of the company. How does your answer compare with that in 3c(ii)?