T UTORIAL 2

Q UEEN ’ S U NIVERSITY B ELFAST

Q UEEN ’ S M ANAGEMENT S CHOOL

Capital Markets (FIN3013)

Week 4
Question 1
The consensus forecast by analysts is that the stock of British Airways (BAY) will pay
a dividend of 4 per share in 2009 and a dividend of 5 in 2010. the stock price is
expected to be 250 at the end of 2010. The estimated required rate of return is 11
percent. Assume all dividends are paid at the end of the year.

1. Using the DDM, estimate the value of British Airways at the end of 2009.

2. Using the DDM, estimate the value of British Airways at the end of 2008.

Question 2
During the period 1960-2007, earnings of the S&P 500 Index companies have in-
creased at an average rate of 8.18 percent per year, and the dividends paid have
increased at an average rate of 5.9 percent per year. Assume that:

• Dividends will continue to grow at the 1960-2007 rate.

• The required return on the index is 8 percent.

• Companies in the S&P 500 Index collectively paid 246.6 billion in dividends in
2007.

Estimate the aggregate value of the S&P 500 Index component companies at the
beginning of 2008 using the Gordon Growth Model.

Question 3
You believe the Grodon (Constant) Growth Model is appropriate to value the stock
of Reliable Electric Corp. The company had an EPS of 2 in 2008. The retention ratio
is 0.60. The Company is expected to earn an ROE of 14 percent on its investments,
and the required rate of return is 11 percent. Assume that all dividends are paid at
the end of the year.

1. Calculate the company’s sustainable growth rate.

2. Estimate the value of the company’s stock at the beginning of 2009.

3. Calculate the present value of growth opportunities.

4. Determine the fraction of the company’s value that comes from its growth op-
portunities.

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Question 4
Stellar Baking Company in Australia has a trailing P/E of 14. Analysts predict that
Stellar’s dividends will continue to grow at its recent rate of 4.5 percent per year into
the indefinite future. Given a current dividend and EPS of 0.7 per share and 2.00 per
share, respectively, and a required rate of return on equity of 8 percent, determine
whether Stellar Baking Company is undervalued, fairly valued, or over valued.

Question 5
You are analyzing the stock of Ansell Limited (ANN), a healthcare company, as of
late June 2008. The stock price is 9.74. The company’s divided per share for the
fiscal year ending 30 June 2008 was 0.27. You expect the dividend to increase by 10
percent for the next three years and then increase by 8 percent per year forever. You
estimate the required return on equity of Ansell Limited to be 12 percent.

1. Estimate the value of ANN using a two-stage dividend discount model.

2. Judge whether ANN is undervalued, fairly valued, or overvalued.

Question 6
Sime Natural Cosmetics Ltd. has a dividend yield of 2 percent based on the current
dividend and a mature phase dividend growth rate of 5 percent a year. The current
dividend growth rate is 10 percent a year, but the growth rate is expected to decline
linearly to its mature phase value during the next six years.

1. If Sime Natural Cosmetics is fairly priced in the marketplace, what is the ex-
pected rate of return on its shares?

2. If Sime were in its mature growth phase right now, would its expected return
be higher or lower, holding all other facts constant?

Question 7
You are trying to value the stock of Resources Limited. Your projections for the next
four years are based on the following assumptions:

• Sales will be 300 million in Year 1.

• Sales will grow at 15 percent in Years 2 and 3 and 10 percent in Year 4.

• Operating profits (EBIT) will be 17 percent of sales in each year.

• Interest expense will be 10 million per year.

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 • Income tax rate is 30 percent.

• Earnings retention ratio will stay at 0.60.

• The per-share dividend growth rate will be constant form Year 4 forward, and
the final growth rate will be 200 basis points less than the growth rate from
Year 3 to Year 4.

The company has 10 million shares outstanding. The required return on the stock is
estimated to be 13 percent.

1. Estimate the value of the stock at the end of Year 4.

2. Estimate the current value of the stock.

3. Estimate the current value of the stock if the sales growth rate in Year 3 is 10
percent instead of 15 percent.