7) Tom Smithfield is valuing the stock of a food-processing business. He feels c

Q: 7) Tom Smithfield is valuing the stock of a food-processing business. He feels c

a) Price =P/E * E3 = 12*3 = 36 b) g = ROE*(1-dividend payout) = 0.1*(1-0.45) = 0.055 Terminal = D3*(1+g) / (r - g) = 0.45*3*(1+0.055) / (0.09 - 0.055) = 40.69 Gordan model gives higher terminal value

ID: 2805903 • Letter: 7

Question

7) Tom Smithfield is valuing the stock of a food-processing business. He feels confident explicitly projecting earnings and dividends to three years (to t = 3). Other information and estimates are as follows:

Required rate of return = 0.09.

Average dividend payout rate for mature companies in the market = 0.45.

Industry average ROE = 0.10. E3 = $ 3.00.

Industry average P/ E = 12.

On the basis of this information, answer the following questions:

A) Compute terminal value (V3) based on comparables.

B) Contrast your answer in Part A to an estimate of terminal value based on the Gordon growth model.

Explanation / Answer

Price =P/E * E3 = 12*3 = 36

g = ROE*(1-dividend payout) = 0.1*(1-0.45) = 0.055

Terminal = D3*(1+g) / (r - g) = 0.45*3*(1+0.055) / (0.09 - 0.055) = 40.69

Gordan model gives higher terminal value

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7) Tom Smithfield is valuing the stock of a food-processing business. He feels c

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