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VALUATION
Mendoza M
1. Ms A Co plans to use the price/earnings multiple approach to estimate the
value of L Corp’s stock, which she currently holds in her retirement account.
She estimates that L Company will earn P2.60 per share next year (20-1).
This expectation is based on an analysis of the firm’s historical earnings trend
and of expected economic and industry conditions. She finds the
price/earnings (P/E) ratio for firms in the same industry to average 7. What is
the value of L Co shares of stock?
Value of L co. Stocks using P/E ratio
P/E ratio =MV/EPS
7 times = MV/P 2.60
Market Value = P 18.20
2. Common stock valuation P Motors’ common stock just paid its annual dividend of
P1.80 per share. The required return on the common stock is 12%. Estimate the
value of the common stock under each of the following assumptions about the
dividend:
a. Dividends are expected to grow at an annual rate of 0% to infinity.
Zero Growth
Value = Div/required return
= 1.80 / .12
= P 15
b. Dividends are expected to grow at a constant annual rate of 5% to infinity.
Growth 5%
Cost of equity = (Div/sh/MV) + g
(Required return)
.12 = (1.80x1.05)/MV +.05
.12 = (1.89/MV) +.05
.07 = 1.89/MV
MV = P 27
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3. Ed Footwear wishes to assess the value of its Active
Shoe Division. This division has debt with a market value of P12,500,000 and no
preferred stock. Its weighted average cost of capital is 10%. The Active Shoe
Division’s estimated free cash flow each year from 20-6 through 20-9 is given in the
following table. Beyond 20-9 to infinity, the firm expects its free cash flow to grow
at 4% annually.
Year (t)
Free cash flow
PV factor
20-6
P 800,000
.909
727,200
20-7
1,200,000
.826
991,200
20-8
1,400,000
.751
1,051,400
20-9
1,500,000
+
26,000,000
27,500,000
.683
18,782,500
TOTAL VALUE OF ACTIVE SHOE DIV
21,552,300
Estimate 20-10 / FCF
1,500,000 x 1.04
1,560,000 / .10-.04 =
26,000,000
a. Use the free cash flow valuation model to estimate the value of Ed’s entire
Active Shoe Division. P = 21,552,300
b. Use your finding in part a along with the data provided to find this division’s
common stock value.
TOTAL VALUE OF DIV – Value of Debt – Value of Pref = Value of Common
21,552,300 – 12,500,000 – 0 = 9,052,300
c. If the Active Shoe Division as a public company will have 500,000 shares
outstanding, use your finding in part b to calculate its value per share
P 9,052,300 / 500,000 sh = P 18.10
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4. La Company, a small cosmetics company, from 20-0 through 20-5 paid the
following per-share dividends:
Year
Dividend per share
20-5
P1.40
20-4
1.29
20-3
1.20
20-2
1.12
20-1
1.05
20-0
1.00
We assume that the historical annual growth rate of dividends is an accurate
estimate of the future constant annual rate of dividend growth, g. The required return
is 15%.
a. Find the historical annual growth rate of dividends = 7%
Trial at 10%
.621 x P 1.40 = P 0.87
Trial at 7%
.713 x P 1.40 = P 1.00
b. How much is estimated dividend in 20-6
(1.40 x 1.07) = P 1.50
c. Find the value of La Co stock
.15 = (1.40 x 1.07)/ MV + .07
.08 = 1.50/MV
MV = P 18.75
20-5
P 1.40
20-0
P 1.00
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