Beagle Beauties engages in the development, manufacture, and sale of a line of c

Question

Beagle Beauties engages in the development, manufacture, and sale of a line of cosmetics designed to make your dog look glamorous. Below you will find selected information necessary to compute some valuation estimates for the firm. Assume the values provided are from year-end 2015. Also assume that the firm’s equity beta is 1.40, the risk-free rate is 2.40 percent, and the market risk premium is 6.8 percent.

The required return is 11.92 percent. Use the clean surplus relationship to calculate the share price for Beagle Beauties with the residual income model. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Dividends per share $ 3.12 Return on equity 12.00 % Book value per share $ 17.50

Explanation / Answer

Cost of equity = risk free rate + beta (market risk premium - risk free rate)

Cost of equity = 2.40 + 1.4 (6.8-2.40) = 2.40 + 6.16 = 8.56%

equity charge = book value per share * cost of equity

equity charge = $17.50 * 8.56% = $1.498

Residual income = EPS - equity charge

EPS at end = $5.90 * (1+13.66%) = $6.70594

Residual income = $6.70594-$1.498 = $5.21

Stock price = book value + Residual income/(1+required rate of return)

Stock price = 17.50 + 5.21/(1+0.1192) = 17.50 + 4.66= $22.16

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