A. P/E and Value JJ Industries retains 35% of its income. Last year\'s EPS was $

Question

A.

P/E and Value JJ Industries retains 35% of its income. Last year's EPS was $2.35 and ROE is 10%. Investors require a 8% return on this stock. What is the intrinsic value of the stock?

$21.16

$19.50

$18.71

$23.78

B.

Free Cash Flow to Equity This year a firm has FCFF of $10.75 million. The firm has interest expense of $7 million and is in a 34% tax bracket and debt increased by $4 million. The firm's free cash flow to equity is ____________ million.

$6.13

$10.13

$-.25

$10.75

P/E and Value JJ Industries retains 35% of its income. Last year's EPS was $2.35 and ROE is 10%. Investors require a 8% return on this stock. What is the intrinsic value of the stock?

Explanation / Answer

A. We are required to calculate the intrinsic value of the stock for which we shall use the GORDON GROWTH MODEL.

But first, we need to calculate the growth rate,

Growth rate = ROE * Retention ratio

Growth rate = 0.10 * 0.35 = 0.035 i.e. 3.5%

Now, we need to find EPS = EPS of last year + growth rate

EPS = 2.35 + 3.5% = 2.4323

Dividend = EPS * Payout ratio = 2.43 * 35% = 0.8513

Now, we use GORDON GROWTH MODEL to calculate intrinsic value (P0)

P0 = Dividend / (Ke - g) where g = growth and Ke = cost of equity

P0 = 0.85 / (0.08 - 0.035)

P0 = $ 18.89 (approx = 18.71 given in options) we go for the nearest option. These decimal difference is due to rounding off.

B. The formula is : FCFE = FCFF - Interest (1-tax) + Net borrowings

FCFE = 10.75 - 7(1-0.34) + 4

FCFE = 10.75 - 4.62 + 4

FCFE = $ 10.13

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