Answer THREE questions: a) Salamander Corporation has just announced a £1.50 per

Question

Answer THREE questions: a) Salamander Corporation has just announced a £1.50 per share dividend for the upcomingyear (with the company having 2 million shares outstanding). The board has also announced that both sales and targets are looking positive and that they expect dividends to grow at a rate of 5% per year indefinitely. The stock of Salamander Corporation has a beta of 0.8 While the expected market return and risk free rates are 22% and 5% respectively The company's accountant also estimate that with further investment, the future cash flows of the company are to be as follows (2014 is termed year zero) 2014 £6.4 mil 2015 £7.2 mil 2016 £7.5 mil 2017 2018-2030 E8.2 mil 8.5 mil p.a i) Calculate the return Salamander Corporation can expect from its stock. (2 %) i) Determine the value of the share in Salamander using the dividend discount model (5 %) ii) Determine the value of a share in Salamander using the discounted (10 %) iv) Given that the industry average P/E ratio is 5 and its eamings' figure is (3 %) cash flow method £6 millions, calculate the value of a Salamander share b) Compare and contrast the altenative approaches of fundamental analysis and technical analysis in assessing the prospects of a future investment opportunity. Your answer should include a(-) relevant example(s) of each methodology (13% %)

Explanation / Answer

1. a. i. Calculation of expected rate of return

Re = Rf + b(Rm -Rf)

where, Re is expected rate of return

Rf = Risk free rate of return

b is Beta of stock

Rm is market rate of return

Re = 5 + 0.8*(22-5) = 5 + 13.6 = 18.6%

Expected return on Salamander stock = 18.6%

ii. Calculation of value of share using dividend discount model:

We know that

P = D1/ (ke-g)

where P is price of stock

D1 is dividend of the next year (when we are standing at year 0)

ke is cost of equity or return on equity

g is growth rate

This implies, P = 1.50/(0.186 - 0.05) = 1.50/ 0.136 = 11.0294

Thus, the value of Salamander stock = 11.03 pounds

Note:

1. It is assumed that required rate of return is equal to expected rate of return.

2. D1 is taken as 1.50 per share as this is the dividend for upcoming year and not current year.

iii. Calculation of value of stock under discounted cash flow method:

Value of cash flows of 2018-2030 at the beginning of 2018

= 8.5* Present Value Annuity Factor ( 13 years, 18.6%)

= 8.5* 4.791 = 40.7235

Present value of Cash Flows of 2018-2030 = 40.7235 discounted for 3 years at 18.6%

= 40.7235* 0.5994 = 24.4096659

Total present value of cash flows = 16.31787+24.4096659

= 40.7275359 million

Value of stock = Present Value of cash flow/Number of shares

= 40.7275359million /2 million

= 20.36376795 per share

That is value of stock = 20.37 pounds approximately

iv. P/E ratio = Price/Earnings

5 = Price/6

Price = 30 millions

Value of one share = 30 millions/2 millions = 15 pounds

Year Dividend (in millions) PV Factor at 18.6% PV 2015 7.2 .8432 6.07104 2016 7.5 .7109 5.33175 2017 8.2 .5994 4.91508 Total 16.31787

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