Greymare Ltd is a very large UK company, listed on AIM. With a growing reputatio

Question

Greymare Ltd is a very large UK company, listed on AIM. With a growing reputation for delivering top quality products on time and on budget, the future looks bright for Greymare Ltd. Research into the 2013/14 company accounts and extensive discussions with market analysts have given the following information on Greymare Ltd: ROE-1296 i) ii) iii) iv) cia : : 1.3 This year's EPS = £3.50 They plan to maintain their traditional plowback ratio of 2/3 Greymare Ltd have just paid their annual dividend and the market consensus is that the 2014/15 market return should be 20% with a current T-bill offering 5% 1) Using the above information find the price at which Greymare Ltd stock should sell. 2) Calculate both the leading and trailing price earnings ratios and explain why you would want to know both. 3) Calculate the present value of growth opportunities. 4) Suppose your research convinces you Greymare Ltd will announce, momentarily, that it will immediately reduce its plowback ratio to 1/3 Find the intrinsic value of the stock under this new condition 5) If the market is still unaware of this decision, explain why the intrinsic value no longer equals the present value. Which value is greater (i.e. the intrinsic value or the present value)?

Explanation / Answer

1) R= (Rf + (Rm – Rf) * ?

Rf = 6 %, Market return Rm= 20%, Beta = 1.3

Return (R) = .06 + ( .2 - .06) *1.3   = .242 = 24.2 %

Growth (g) = ROE * Plowback Ratio (Retention ratio)

                   = .12 *(2/3) = .08 = 8%

Plow backRatio = 2/3 = (1 - (Dividends / Net Income)

Dividends / Net Income = 1 - (2/3) = 1/3 = Payout ratio

P / EPS = (Payout Ratio * (1+ g) / (R-g) = ((1/3) * (1.08)) / (0.242 - .08) = 0.36 / 0.162 = 2.23

P = 2.23 * 3.5 = 7.805

2 - PE Multiple = 7.805 / 3.5 = 2.23

PE multiple of company is compared with industry PE to determine whether the compny is overvalued or undervalued. It is also used to differntiate between groth stocks and value stocks.

4- g = ROE * Plowback Ratio = 0.12 *1/3 = 0.04

    (P/EPS) = (D1/ EPS) / (R - g), D1 = D0 * (1 + g) = ((D0 * (1 + g))/EPS) / (R-g)

D0 / EPS = Payout Ratio = 1 - Plowback Ratio = 1 - (1/3) = 2/3

EPS = 3.5

( P / 3.5) = ((2/3)*(1 +.04)) / (0.242 - .04), (P/3.5) = 0.693 / .202.

P = 3.5 * 3.43 = 12

5- Higher retention rates are not always considered good for stock price because dividend is a of the major factor for stock valuation. However, since company is in the growth stage it means stock is continually appreciating because of company growth. The decision of further decreasing plowpack ratio the Present value will be greater than intrinsic value..

           

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