South Africa (SA) Treasury bills yield 4 percent;

30-year SA Treasury bonds yield 8 percent.

LCC AOC
Current stock price R40 R20
shares outstanding 8 million 14 million
Projected earnings per share R5 R12.3
Projected dividend per share R0.5 R2.3
Projected dividend growth rate 6% 8%
Stock beta 1.7 1.2
Investor's required return 15% 16%
Long term debt R80 million R120million
Stock holders’ equity R250 million R220 million

a. Calculate the value of the common stock of LCC and AOC using the constant growth DDM. Show
your work.

b. Calculate the expected return over the next year of the common stock of LCC and AOC using the
CAPM. Show your work.

c. Calculate the internal (implied, normalized, or sustainable) growth rate of LCC and AOC. Show
your work.

d. Recommend LCC or AOC for investment. Justify your choice using your answers to A, B, and C
and the information in Table above.

A.

Using the constant-growth dividend discount model, V0 = D1 / ( r - g)

For LCC: V0 = R0.5 / ( 0.15 - 0.06 ) = R5.56

For AOC: V0 = R2.3 / ( 0.16 - 0.08) = R28.75

B.

Using the CAPM, the expected return r = Rf + β [ E (Rm) – Rf ]

For LCC: r = 4% + 1.7 ( 15% - 4% ) = 22.7%

For AOC: r = 4% + 1.2 ( 15% - 4% ) = 17.2%

C.

The internal growth rate is g = b * ROE = [ (E - D ) / E ] * ( E/BV )

For LCC: BV = R250/8 = R31.5

g = [ (R5 - R0.5 ) / R5 ] * ( R5/ R31.5 )

= 0.9 * 15.87% = 14.28%

For AOC: BV= R220/14 = R15.71

g = [ (R12.30 - R2.3 ) / R12.3 ] * ( R12.3/ R15.71 ) = 0.813 * 78.29% = 63.64%

D.

Recommendation: Aminochem (AOC) is a more attractive investment than Litchfield (LCC)

based on the answers to parts A, B, and C.