Question 5 (10 Marks) company has 2,000,000 ($1) shares with present earnings of

Question

Question 5 (10 Marks) company has 2,000,000 ($1) shares with present earnings of $1,000,000 and a dividend payout ratio of 50%. The dividend is expected to grow by 5 % annually The expected rate of return for shareholders is 14% and the company's net tangible assets are $3,800,000. Required: (a) Using the Capitalisation of Earnings Method, calculate a theoretical value of one share (or if you wish, the whole company). You can assume that earnings will be maintained at $1,000,000 per annum into the future. Using the Dividend Growth Model Method, calculate a theoretical value of one share (or if you wish, the whole company). (b) Calculate an estimate of the companys goodwill wsing the frm's current market value of $2.30 per share.

Explanation / Answer

Capitalization of earnings is a method of determining the value of an organization by calculating the net present value (NPV) of expected future profits or cash flows. The capitalization of earnings estimate is determined by taking the entity's future earnings and dividing them by the capitalization rate (cap rate). This is an income-valuation approach that determines the value of a business by looking at the current cash flow, the annual rate of return and the expected value of the business (a) Value of the company=Earning/((discount rate-growth rate) future Earning=1,000,000 Discount rate= 14% Growth in earning =0% Value of company=1,000,000/(.14-0)          71,42,857 No fo Shares 20,00,000 Theoretical Value per share=7142857/2000000                     3.57 Per Share (b) Dividend (D0)=1000000*50%/2000000 0.25 Per Share Growth annual 5% Ke 14% Price of the share(P0)=D0*(1+g)/(ke-g) =.25*(1+.05)/(.14-.05)                     2.92 Per Share (c ) Estimate of company goodwill Market value of company=2.3*2000000          46,00,000 Less: Company Net Tangible Assets          38,00,000 Goodwill            8,00,000

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