Benchmark Metrics Inc. (BMI), an all-equity financed firm, reported EPS of $5.77

Question

Benchmark Metrics Inc. (BMI), an all-equity financed firm, reported EPS of $5.77 in 2013. Despite the economic downturn, BMI is confident regarding its current investment opportunities. But due to the financial crisis, BMI does not wish to fund these investments externally. The Board has therefore decided to suspend its stock repurchase plan and cut its dividend to $1.26 per share (vs. almost $2 per share in 2012), and retain these funds instead. The firm has just paid the 2013 dividend, and BMI plans to keep its dividend at $1.26 per share in 2014 as well. In subsequent years, it expects its growth opportunities to slow, and it will still be able to fund its growth internally with a target 45% dividend payout ratio, and reinitiating its stock repurchase plan for a total payout rate of 58%. (All dividends and repurchases occur at the end of each year.)

Suppose BMI's existing operations will continue to generate the current level of earnings per share in the future. Assume further that the return on new investment is 15%, and that reinvestments will account for all future earnings growth (if any). Finally, assume BMI's equity cost of capital is 10%.

a. Estimate BMI's EPS in 2014 and 2015 (before any share repurchases).

b. What is the value of a share of BMI at the start of 2014 (end of 2013)?

Hint: Make sure to round all intermediate calculations to at least four decimal places and show your work.

Explanation / Answer

a) Earnings growth g = = (retention rate) × RONI RONI (given) 15.00000% Retention Rate 2014 = 1 - DPS/ EPS ; 1 - $1.26/$5.77 78.16291% Growth Rate 2014 = 78.16% x 15% 11.72444% EPS 2014 = $5.77 x (1+ 11.72%) $6.45 Retention Rate 2015 = 1 - DPS/ EPS ; 1 - $1.26/$6.45 80.45451% Growth rate 2015 = 80.45451% x 15% 12.06818% EPS 2015 = $6.45 x (1+12.06818%) $7.22 b) Payout Ratio for 2015 58.00% Retention Ratio for 2015 = ( 1 - 58%) 42.00% DPS = $7.22 x 58% 4.1902 Growth rate 2015 = 42% x 15% 0.0630 Price in 2015 = DPS /(r - g) Price in 2015 = 4.19 /(10% - 6.30%) 113.2485 Price in 2014 = Price in 2015 will discounted at 10% Price in 2014 = $1.26 + $113.25/(1.10)^1 $104.1

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