Fin550 fin560 6. Lauren Entertainment, Inc., has an 18 percent annual growth rate compared to the market rate of 8 percent. If the market multiple is 18, determine P/E ratios for Lauren Entertainment, Inc., assuming its beta is 1.0 and you feel it can mai

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Home>Business & Finance homework help>Accounting homework help>Fin550 fin560 6. Lauren Entertainment, Inc., has an 18 percent annual growth rate compared to the market rate of 8 percent. If the market multiple is 18, determine P/E ratios for Lauren Entertainment, Inc., assuming its beta is 1.0 and you feel it can mai

Q6

Lauren entertainment Answer
Annual growth rate 18% a. Growth rate for the next 10 years
Market growth rate 8% LnX= time(1+annual growth rate)/(1+market growth rate)
Market multiple 18 lnX= 10(1+18%)/(1+8%)
Beta 1.0 Lnx = 10.9259259259
x= 2.3911384903
per earning ratio = 43.040492826
Growth rate for : a. the next 10 Years
b. The next 5 Years b. Growth rate for the next 5 years
LnX= time(1+annual growth rate)/(1+market growth rate)
lnX= 10(1+18%)/(1+8%)
Lnx = 5.462962963
x= 1.6979913098
per earning ratio = 30.563843576

Q7

Company A Company B S&P industrials Answer
P/E ratio 30 27 18 a. Compute the growth duration of each company stock relative to the S&P Industrials.
Expected annual growth rate 0.18 0.15 0.07
Dividend yield 0 0.01 0.02
Implied growth duration Company A Company B S&P industrials
9.00 9.90 -12.90
b. Compute the growth duration of Company A relative to Company B.
6.2 Years
c. Given these growth durations, what determines your investment decision?
Growth Duration - It measures the length of time (holding period) needed to justify the spread between a stock's P/E and the benchmark's P/E. With this analysis we can directly compares 2 companies in same industry. It evaluate high P/E ratios by relating P/E ratio to the firms rate and duration of growth. Stock with low P/E relative to its growth rate is undervalued. Undervalue stock are potentials for higher return in long term.

Q8

Answer
a. Identify the three factors that must be estimated for any valuation model, and explain why these estimates are more difficult to derive for common stocks than for bonds.
1 . The expected stream of returns - It is not certain for commin stock and is specified for bonds in terms of interest and principal payments.
2 . Time pattern of expected returns- It is specified for bonds in terms of semi annual interest and annual principal payments and is uncertain for common stock.
3 . The required rate of return on the investment adjusted for risks is uncertain for both stocks and bonds. This depends on the risk free rate prevailing in the market.
b.
1 . When a corporation is subjected to cyclic swings in its business the constant dividend growth is unrealistic.
2 . Dividend growth rate might be slower in some mature and large companies. However they might maintain the growth rate by increasing the payout ratio.
3 . Some of the small companies cannot be able to manage above the average growth rate.

Q10

Price of stock today (p) $20 Answer
Expected growth rate of dividends (g) 8% a. Using only the preceding data, compute the expected long-term total return on the stock using the constant-growth dividend discount model.
Annual dividend one year forward (d) $0.60
Dividend discount model is : P= D/(k-g)
Where k is the long term total return on stock
K= (D/P)+g
11%
b. Briefly discuss three disadvantages of the constant-growth dividend discount model in its application to investment analysis
1 . It bases on the unnecessary and impossible assumption that the dividend growth will be constant.
2 . It is only used by small investors not by strategic investors when purchasing the whole company
3 . It is not applicable when the growth rate is more than the rate of return. It therefore asssumes that the rate of return will always be more.
c. Identify three alternative methods to the dividend discount model for the valuation of companies.
1 . Net asset Value method
2 . Price earning ratio method
3 . Discounted cash flow method

Q11

Stock Beta Analys's Estimated return Answer
A 1.2 16% a.
B 0.8 14% 1 .
Risk free return 4.50%
Market return 14.50%
b. k=RFR +beta(RM-RFR)
Stock A : 16.50%
Stock B: 12.50%
Stock A is undervalue by the Analyst because the actual return for stock A and 16.50%. Stock B has been undervalued by the analyst brcause the actural return for the stock B is 12.50%.

Beta

1.2

E(R)

0.8

16.50

12.50

4.50

Beta

1.2

E(R)

0.8

16

14

4.50

Q12

Answer Revenue Net income Assets
a. 1 identify and calculate the three components of the DuPont formula $5,140 $510 Beginning Ending
Components $2,950 $3,100
a. Profit margin : Net Profit/Revenue 10% Average 3025
b. Asset turnover Sales revenue/Average assets $1.66 Equity
c. Financial leverage 1.41 $2,200
Annual dividend per year $0.55
2 calculate the ROE for 2011, using the three components of the DuPont formula
ROE: Profit margin * Asset turnover * Financial leverage
2011 ROE : 23.18% Answer
b. Once the sustainable growth rate is more than the sctual growth rate, the business is sad to be underpoerforming. It is therefore necessary for the business to take appropriate action.
3 calculate the sustainable-growth rate for 2011
1 . The business has to be focused in growing revenues without minding about the profit margins effects
Dividend rate 0.29
Business retention rate 71.42% 2 . The business should work more on improving the working capital by putting in the right control measures.
Sustainable growth rate = ROE * Business retention rate
16.56%