Question

Fleury Security Limited (FSL) is projected to have earnings per share (EPS) of $3.50 next year, and the firm’s dividends are 30% of earnings. Investors have a required return on FSL shares of 12.4%. The company has a profit margin of 10%, total asset turnover of 0.9, and total debt ratio of 0.4.

a) Calculate the ROE of the company.
b) Calculate the price of FSL shares.
c) How much of that price is due to future growth opportunities?

Answer 1

Answer and Explanation:

The computation is shown below:

a) For ROE of the company

As we know that

Debt ratio = 1 - (1 ÷ Equity multiplier)

0.4 = 1 - (1 ÷ Equity multiplier)

(1 ÷ Equity multiplier) = 0.6

Equity multiplier = 1 ÷ 0.6

= 1.6667

Now ROE is

ROE = Net Profit Margin × Total Asset Turnover × Equity multiplier

= 10% × 0.9 × 1.6667

= 15%

b) For the Price of FSL shares

Expected Dividend next year (D1) = Projected EPS × Dividend payout ratio

= $3.50 × 30%

= $1.05

And, Required Return(ke) = 12.4%

Growth Rate(g) = ROE × (1 - Dividend payout ratio)

= 15% × (1 - 0.30)

= 10.5%

And finally the Price of STock:-

= D1 ÷ (ke - g)

= $1.05 ÷ (0.124 - 0.105)

= $55.26

C. For Present Value of Growth Opportunity(PVGO)

As we know that

Present Value of Growth Opportunity(PVGO) = Stock Price - (EPS ÷ Ke)

= $55.26 - ($3.50 ÷ 12.4%)

= $27.03