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Nusa_Havoro · Sep 26, 2009, 10:49 PM

discount rate = 15%
gross revenues last year = $3 million
total costs =$1.5 million
gross revenue and costs expected to grow @ 5% per year

can any one help to solve that question

morgaine300 · Sep 27, 2009, 01:43 AM

Please see the guidelines for posting homework problems:
Ask Me Help Desk - Announcements in Forum : Homework Help

Can you show us your attempts at solving the problem?

Nusa_Havoro · Sep 27, 2009, 06:02 PM

Well this is my attempts from this question
EPS = Net earning / outstanding shares
= (3 - 1.5) / 1
= 1.5

Price per share = EPS / Discount rate - growth
= 1.5 / (.15 - .05)
= $15

Is this correct...

Nusa_Havoro · Sep 27, 2009, 06:18 PM

Originally Posted by morgaine300

Please see the guidelines for posting homework problems:
Ask Me Help Desk - Announcements in Forum : Homework Help

Can you show us your attempts at solving the problem?

Well this is my attempts from this question
EPS = Net earning / outstanding shares
= (3 - 1.5) / 1
= 1.5

Price per share = EPS / Discount rate - growth
= 1.5 / (.15 - .05)
= $15

Is this correct...

morgaine300 · Sep 27, 2009, 06:27 PM

Double posting won't get an answer quicker. Please be patient until someone who can answer it comes along. (Any of us will point you to the homework guidelines, but you need to wait for someone who does finance to check it for you.)

ArcSine · Sep 28, 2009, 06:55 AM

Nusa Havoro, it looks like you've got an idea of how to proceed, but we'll have to polish it up just a bit.

You're correct in using a Constant Growth Model for the basic valuation, which sets up as...

$V\ =\ \frac{C_1}{r-g}$

V is the value of a cash flow stream which is growing at a fixed rate g; $C_1$ is the amount to be received one year after the valuation date; and r is the discount rate.

So far, so good... I see this is the pricing approach you're taking. Now for the polishing-up part.

First, your computation implies that there are 1M shares outstanding. Since this isn't stated explcitly in your information, confirm from your text that this is the correct number of outstanding shares.

Next, notice that I emphasized "one year after the valuation date", above. Suppose we're pricing the stock as of today, using the CG Model. We need $C_1$ to be next year's cash flow. According to your info, it was $1.5M last year. If it's growing at a fixed 5%, what will it be this year, and then next year?

So if you'll (1) compute next year's net earnings given the 5% annual growth rate; and (2) confirm that the earnings are indeed spread across 1 M shares; then you should be fine pricing the stock with the CG Model.