16/02/2011

Chapter 6 & 7

Presented by
Group V
INEZ, IRENE,
WINARDI, RENDY

SUAREZ MANUFACTURING

Assesing the Impact of Suarez Manufacturing’s

Proposed Risky Investment on Its Stock Value

Historical Firm’s Common Stock Dividend

Year Dividend / Share
2009 $ 1.90
2008 $ 1.70
2007 $ 1.55
2006 $ 1.40
2005 $ 1.30

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SUAREZ MANUFACTURING

Comparison Between Two Options

Not Undertaking Investment
Dividend in 2010 $ 2.09
Required Return 14 %

Undertaking Investment
Dividend in 2010 $ 2.15
Required Return 16 %
GROWTH
Best Case Worst Case
2010 To ∞ 13 % 2010 To 2012 13 %
2013 To ∞ 10 %

SUAREZ MANUFACTURING

Find the Current Value Per Share

P0 = D1
(r – g*)
= $ 2.09
(0.14 – 0.10)

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SUAREZ MANUFACTURING

*) Determining Growth 2005 - 2009

(From Table A.2 Appendix A)

D2004 1 D$1.30
= = PVIFg, 4 = 0.684
D2009 (1 + g)4 D$1.90

n 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1 .990 .980 .971 .962 .952 .943 .935 .926 .917 .909
2 .980 .961 .943 .925 .907 .890 .873 .857 .842 .826
3 .971 .942 .915 .889 .864 .840 .816 .794 .772 .751
4 .961 .924 .888 .855 .823 .792 .763 .735 .708 .683

SUAREZ MANUFACTURING

Find Value Per Share if Undertake the Investment

(Assume dividend growth stays 13% forever)
Undertaking Investment
Dividen 2010 $ 2.15
Required Return 16 %
GROWTH
Best Case Worst Case
2010 To ∞ 13 % 2010 To 2012 13 %
2013 To ∞ 10 %

D1 $2.15
P0 = = =
(r – g) (0.16 – 0.13)
Investment results an increase on the value of firm’s stock,
because there’s an increase in return of dividend.

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SUAREZ MANUFACTURING

Do the Stockholders Win?

Should the Firm Undertake the Investment?
Stockholders WIN! As the result of
undertaking the investment.

Yes, the firm should undertake the proposed

investment because:

STOCK VALUE
DIVIDEND

SUAREZ MANUFACTURING

Find value per-share if undertake investment

(Assume at 2013 dividen growth return to 10%)

Undertaking Investment
Dividen 2010 $ 2,15
Required Return 16 %
Growth
Best Case Worst Case
2010 To ∞ 13 % 2010 To 2012 13 %
2013 To ∞ 10 %

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SUAREZ MANUFACTURING

Project Dividend Per Share

Year Growth Dividen/share

2010 = $ 2,15
2011 13 % = $ 2,15 x ( 1 + 0,13)
= $ 2,43
2012 13 % = $ 2,43 x (1 + 0,13)
= $ 2,75
2013 10 % = $ 2,75 x (1 + 0,10)
= $ 3,03

D2013 $3.03
P2013 = = =
(r – g) (0.16 – 0.10)

SUAREZ MANUFACTURING

g = 13% g = 13% g = 13% g = 10%

2009 2010 2011 2012

D2010 = $2,15 D2011 = $2,43 D2012 = $2,75

PV (D2010)
PV(D2011)
PV(D2012)
PV(P2012)

Required Return Value Present Value

Dividend 2010 16 % $ 2,15 $ 1,85

Dividend 2011 16 % $ 2,43 $ 1,81
Dividend 2012 16 % $ 2,75 $ 1,76
Share Value 2012 16 % $ 50,5 $ 32,35

STOCK VALUE (if firm is undertaking the investment) =

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SUAREZ MANUFACTURING

Investment will decrease the firm’s stock

value, because growth rate of dividend is
below the required return.

Stockholders LOSE! As the result of

undertaking the investment.

Firm should not undertake the proposed

investment because :

STOCK VALUE
DIVIDEND

ENCORE INTERNATIONAL

Firm’s Financial Data:

Data Item 2009 value
Earning per share (EPS) $ 6,25
Price per share of common stock $ 40,00
Book value of common stock equity $ 60.000.000
Total common shares outstanding 2.500.000
Common stock dividend per share $ 4,00

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ENCORE INTERNATIONAL

Firm’s Current Book Value Per Share:

$ 60,000,000
=
2,500,000

Price Earning per Ratio (P/E):

$ 40
$ 6.25 =

ENCORE INTERNATIONAL

Assume b=1.10
Required Return & Risk Premium…?
Data Points
rj = RF+ [b(rm - RF)]
b r
0,00 6,00 % RF
0,25 8,00 % RISK PREMIUM
0,50 10,00 %
0,75 12,00 %
rj = 6%+[1.1(14% - 6%)]
1,00 14,00 % rm
1,25 16,00 %
1,50 18,00 % = 6% +
1,75 20,00 %
2,00 22,00 % =

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ENCORE INTERNATIONAL

Assume b=1.25
Required Return & Risk Premium…?
Data Points
rj = RF+ [b(rm - RF)]
b r
0,00 6,00 % RF
0,25 8,00 % RISK PREMIUM
0,50 10,00 %
0,75 12,00 %
rj = 6%+[1.25(14% - 6%)]
1,00 14,00 %
1,25 16,00 % rm = 6% +
1,50 18,00 %
1,75 20,00 % =
2,00 22,00 %

ENCORE INTERNATIONAL

If beta rises as expected from1.10 to 1.25, then…

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ENCORE MANUFACTURING

If NO GROWTH on Future Dividend…

g = 0%
rm = 16,0 %
b = 1.25

D0
P0 =
(r – g)

$4
=
(0.16 – 0)

ENCORE MANUFACTURING

If the Firm can Maintain a Constant Annual 6%

Growth in Future Dividend
b = 1.25 rm = 16%

D0(1+g)
P0 =
(r – g)

$4(1 + 0.06)
=
(0.16 – 0.06)

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ENCORE MANUFACTURING

If the Firm can Maintain a Constant Annual 8%

Growth Over the Next 2 Years and 6% Thereafter
(beta = 1.25)
Projected dividen per-share:
Year Growth Dividen/share
2009 = $ 4,00
2010 8 % = $ 4,00 x ( 1 + 0,08) = $ 4,32
2011 8 % = $ 4,32 x (1 + 0,08) = $ 4,67
2012 6 % = $ 4,67 x (1 + 0,06) = $ 4,95

D0 $4.95
P0 = = =
(r – g) (0.16 – 0.06)

ENCORE MANUFACTURING

g = 8% g = 8% g = 6%

2009 2010 2011 2012

D2010 = $4,32 D2011 = $4,67

PV (D2010)
PV (D2011)
PV (p2010)

Required Value Present Value

Return
Dividen 2010 16 % $ 4,32 $ 3,72
Dividen 2011 16 % $ 4,67 $ 3,47
Share Value 2011 16 % $ 49,50 $ 36,79

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ENCORE MANUFACTURING

Stock Value Comparison

Expansion Expansion
Expansion
Current with with Variable
Book Value with No
Constant Growth
2009 Growth
Growth (6%) (8% & 6%)
$ 40 $ 24 $ 25 $42.4 $ 43.98

 The value may differ due to the existing differences in future’s

growth prediction.
• The valuation method which clearly represents the true
value on Encore Stock would be ‘Expansion with variable
Growth of 8% and 6%’ because, Encore is expanding their
business across the globe, which will possibly increase their
growth in the first 2 years, but afterwards, business will hit
the stage of maturity, whereas the growth will be relatively
lower but stable throughout the years to come.

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