Problem Blueberry Corporation expects to have earnings this coming year of Blueb

ID: 2615348 • Letter: P

Question

Problem Blueberry Corporation expects to have earnings this coming year of Blueberry plans to retain all of its earnings for the next two years the firm will retain 75% orits earnings. It will then retain 50% of its earnings from that point onward. Each year, retained earnings will be invested in new projects with an (21 Marks) ycars For the subsequent two of 15% per year. Any earnings that are not retained will be paid out as comes rom the investment of retained earnings. Blueberry's equity cost of capital is 2% vidends. Assume Blueberry's share count remains constant and all earnings p.a. a. What are the earnings and dividends over the first two years? (6 marks) b. At what rate will the earnings and dividends grow in ycar 3 onwards? What is the dividend at year 3? (4 marks) C. Whet price would you estimate for Blueberry stock? (7 marksy) Now you expect the firm to pay allof its eamings as dividends at the end of year 4 the end of year 4 onwards. Without doing any calculations, can you conclude that the share price increases, decreases, or stays the same compared to your answer in (a)? Explain your answer. (4 marks)

Explanation / Answer

Working Notes:

Like for year 2 = 100% * 15% = 15

Like for year 4 = 75% * 15% = 11.25%

Particulars

Year

EPS Growth Rate

15%

11.25%

11.25

7.5

EPS (Earnings Per Share)

5.75

6.6125

7.3564

8.1840

8.7978

Retention Ratio

100%

75%

50%

Dividend Pay-out Ratio (1 - Retention Ratio)

25%

50%

Dividends (EPS * Dividend Pay-out Ratio)

1.6531

1.8391

4.407

4.3989

Answers-a:

Earnings for first two years = 5 and 5.75

Dividends for first two years = 0 and 0

Answer-b:

Earnings and Dividend will grow at the rate 11.25% for 4th and 5th year then at rate 7.5% forever. Dividends for 3rd year is 1.6531

Answer-c:

P0 = D1 / (Ke – g)

As 5th year onwards growth rate is constant so the value of equity at P5:

P5 = 4.3989 / (12% - 7.5%)

= 4.3989 / 0.045 = $ 97.75

Now we can calculate the price at present by discounting method:

Po = Div3/ (1+ Ke)^3 + Div4/ (1+ ke)^4 + Div5 + PV5/(1 + Ke)^5

= 1.6531/(1 + 0.12)^3 + 1.8391/ (1 + 0.12)^4 + 4.407 + 97.75/ (1 + 0.12)^5

= 1.1766 + 1.1687 + 59.8729

= $ 62.2182 or $ 62.22

Answer-d:

If firm starts paying all of its earnings as dividend at the end of year 4 onwards, then price of share will decrease.

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