$52, then the firm must invest $7. To obtain an expected unlevered cash flow at = 1 of $8.28, t the Gross Profit Margin is assumed to be approximately 26.03%, resulting in expected costs at time 1 of $62.88. The interest expense at time 1, is the cost of debt times the amount of debt outstanding at time zero, or $1.50. The Earnings Before Taxes (EBT) is defined as Sales Costs – Interest Expense Depreciation Expense, which equals $15.63 at time 1. 40% of is the – – EBT taxes paid or $6.25 resulting in a net income (NI) of $9.38. which equals Net ROE, Income/Book Value of Equity at the beginning of the period is 25%. Since the aggregate level of dividends at time 1 is $7.88, then the dividend payout ratio () is 84%. Note that is therefore b equal to 16% and . Further note that the firm will increase its book value of equity via retention of by NI $1.50 (RE in the table). In order to maintain a leverage ratio of 25%, the firm must increase the level of debt from time 0 to time 1 by $0.50. The entries for time periods 2 5 follow the logical – extension of the above discussion, and as shown in the table, the retention rate is 16% and b ROE = 25% for each period. Again the product of and results in the expected growth rate of b ROE 4%. Further note, that imply that sales, costs, book value of asset, depreciation, unlevered cash flow, cash flow to stockholders, value of debt and value of equity to increase by 4% per annum. Investors may use a one-period model in selecting stocks, but future profitability of investment opportunities plays an important role in determining the value of the firm and its EPS and dividend per share. The rate of return on new investments can be expressed as a fraction, c (perhaps larger than 1), of the rate of return security holders require (r): . (46.10)
$52, then the firm must invest $7. To obtain an expected unlevered cash flow at t = 1 of $8.28, the Gross Profit Margin is assumed to be approximately 26.03%, resulting in expected costs at time 1 of $62.88. The interest expense at time 1, is the cost of debt times the amount of debt outstanding at time zero, or $1.50. The Earnings Before Taxes (EBT) is defined as Sales – Costs – Interest Expense – Depreciation Expense, which equals $15.63 at time 1. 40% of EBT is the taxes paid or $6.25 resulting in a net income (NI) of $9.38. ROE, which equals Net Income/Book Value of Equity at the beginning of the period is 25%. Since the aggregate level of dividends at time 1 is $7.88, then the dividend payout ratio () is 84%. Note that b is therefore equal to 16% and . Further note that the firm will increase its book value of equity via retention of NI by $1.50 (RE in the table). In order to maintain a leverage ratio of 25%, the firm must increase the level of debt from time 0 to time 1 by $0.50. The entries for time periods 2 – 5 follow the logical extension of the above discussion, and as shown in the table, the retention rate b is 16% and ROE = 25% for each period. Again the product of b and ROE results in the expected growth rate of 4%. Further note, that imply that sales, costs, book value of asset, depreciation, unlevered cash flow, cash flow to stockholders, value of debt and value of equity to increase by 4% per annum. Investors may use a one-period model in selecting stocks, but future profitability of investment opportunities plays an important role in determining the value of the firm and its EPS and dividend per share. The rate of return on new investments can be expressed as a fraction, c (perhaps larger than 1), of the rate of return security holders require (r): . (46.10)
Alternative_Methods_for_estimating_growth_rate.docx