1. BIC Corporation reported a return on equity of 20% and paid out 37% of its earnings as dividends in the most recent year.
A) Assuming that these fundamentals do not change, estimate the expected growth rate in earnings per share.
B) Now assume that you expect the return on equity to increase to 25% on both new and existing investments next year. Estimate the expected growth rate in earnings per share.
2. Lamps Galore Inc. manufactures table lamps and earns an after-tax return on capital of 15% on its current capital invested (which is $100 million). You expect the firm to reinvest 80% of its after-tax operating income back into the business for the next four years and 30% thereafter (the stable growth period).The cost of capital for the firm is 9%.
A) Estimate the terminal value for the firm (at the end of the fourth year).
B) If you expect the after-tax return on capital to drop to 9% after the fourth year, what would your estimate of terminal value be?