QUESTION 1 VALUATION OF SHARES Tom and Tina are the co-founders of Genesis2 Elec
ID: 2520489 • Letter: Q
Question
QUESTION 1 VALUATION OF SHARES
Tom and Tina are the co-founders of Genesis2 Electronics Ltd, a company that manufactures and installs contemporary models of electronic products for residential and commercial purposes. Genesis2 Electronics Ltd has experienced rapid growth recently because of the new technology that enhances the energy efficiency of its systems. The company is owned equally by Tom and Tina, each holding 100,000 shares. If either wishes to sell the shares, the shares have to be offered first to the other shareholder at an agreed price. Recently Tom and Tina have decided to value their holdings in the company for financial planning purposes. To accomplish this, they have gathered the following information about their main competitors in the industry.
EPS (Cents)
DPS (Cents)
Share Price ($)
ROE (%)
Required rate (%)
Colonial Electronics Ltd
0.42
0.10
8.25
10.5
10.5
Reliable Solutions Ltd
0.66
0.26
6.25
11.5
11.5
Silver Lining Electronics Ltd
-0.24
0.27
22.40
12.5
12.5
Industry Average
0.28
0.21
12.30
11.5
11.5
Last year, Genesis2 Electronics Ltd had an EPS of $2.725 and paid a dividend to Tom and Tina of $102,500 each. The company also had a return on equity of 14.5%. Tom and Tina believe a required rate of return of 12.5% for the company is appropriate.
Required:
Assuming that the company continues its current growth rate (growth rate should be inferred from the data given) into the infinite period, calculate the share price of the company?
EPS (Cents)
DPS (Cents)
Share Price ($)
ROE (%)
Required rate (%)
Colonial Electronics Ltd
0.42
0.10
8.25
10.5
10.5
Reliable Solutions Ltd
0.66
0.26
6.25
11.5
11.5
Silver Lining Electronics Ltd
-0.24
0.27
22.40
12.5
12.5
Industry Average
0.28
0.21
12.30
11.5
11.5
Explanation / Answer
As per the Constant dividend growth model, the price of a share is given by the formula P0 = D1/(r-g) where P0 = Current price D1 = next expected dividend, which is D0*(1+g), D0 being the last dividend r = required return and g = growth rate Substituting values we have Current price of the share = 5*(1+0.05)/(0.12-0.05) = $ 75.00 Growth rate of Genesis2 = ROE*Retention rate ROE = 14.2% give and retention rate = (EPS-DPS)/EPS = (2.725-1.025)/2.725 = 62.39% Growth rate = 0.1420*0.6239 = 8.86% Using the Constant dividend growth model, P0 = D1/(r-g) = 1.025*1.0886/(0.125-0.0886) = $ 30.65
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