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Yakvenalex [24]
1 year ago
14

Assume that Botswana Life Insurance (BOTS LIFE) pays no cash dividends currently and is not expected to for the next 5 years. It

s latest EPS was $10, all of which was reinvested in the company. The firm’s expected ROE for the next 5 years is 20% per year, and during this time, it is expected to continue to reinvest all of its earnings. Starting 6 years from now the firm’s ROE on new investment is expected to fall to 15% and the company is expected to start paying out 40% of its earning in cash dividends, which it will continue to do forever after. BOTS LIFE’s market capitalisation rate is 15% per year.
(a) Estimate the intrinsic value per share of the firm [7 Marks]
(b) Assuming its current market price is equal to its intrinsic value, using illustrations, what do you expect to happen to its price over the next year and the year after? [5 Marks]
(c) Illustrate, what effect would it have on your estimate of the intrinsic value if BOTS LIFE is expected to pay out only 20% of earnings starting in year 6? [5 Marks
Business
1 answer:
Advocard [28]1 year ago
6 0

The intrinsic value of company's share is $89.90

The share price is expected to rise in the incoming years

The intrinsic value of share remains the same when payout ratio reduces to 20%

What is the firm growth rate in each of the future years?

The growth rate of the company, which is also the growth rate for earnings per share in each of the first 5 years

Growth rate in the first 5 years=ROE*reinvestment rate

ROE=20%

reinvestment rate=100%(all earnings would be reinvested)

Growth rate in the first 5 years=100%*20%

Growth rate in the first 5 years=20%

Earnings in 5 years=current EPS*(1+growth rate)^5

Earnings in 5 years=$10*(1+20%)^5

Earnings in 5 years=$24.8832

Growth rate for year 6 and beyond=15%*(1-40%)

Growth rate for year 6 and beyond=9.00%

Earnings in year 6=$24.8832*(1+9%)

earnings in year 6=$27.122688

Out of the EPS, 40% would be paid as dividends

dividends in year 6=$27.122688*40%

dividends in year 6=$10.8490752

We can compute the share price at the end of year using the present value formula of perpetuity

share price in year 5=$10.8490752/(15%-9%)

share price in year 5=$180.81792

share price now=$180.81792/(1+15%)^5

share price now=$89.90

The fact that share price and the intrinsic value are the same implies that share price would increase over the next year and the year after because the dividends would continue to growth at a constant rate of 9%

Out of the EPS, 20% would be paid as dividends

dividends in year 6=$27.122688*20%

dividends in year 6=$5.4245376

growth rate=15%*(1-20%)=12.00%

We can compute the share price at the end of year using the present value formula of perpetuity

share price in year 5=$5.4245376/(15%-12%)

share price in year 5=$180.81792

share price now=$180.81792/(1+15%)^5

share price now=$89.90

The share price in payout ratio from 40% to 20% has no effect on the intrinsic value since the share prices are the same under the two scenarios

Find out more about intrinsic value on:brainly.com/question/14720349

#SPJ1

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