Problem:
Company ABC's shares traded at $83 each in November 2006. Financial analysts were expecting the firm to announce earnings of $3.33 per share for the just-ended October 31 fiscal year and a book value per share of $19.36. The annual dividend per share for fiscal 2006 was 0.64. In addition,analysts were forecasting earnings for fiscal 2007 at $3.75 per share, $4.32 for 2008, and a growth rate in EPS of 12% per year thereafter.
Q1. According to the forecasts and with a cost of equity equal to 12%, should we recommend a buy or sell on Company ABC's stock at the time? Why? [Hint: in order to answer this question, you have to make certain assumptions and calculate the value per share.]
Q2. What was the market's implied long-term growth rate for residual earnings?
Q3. List the difficulties you have in answering questions (a) and (b). What other information would you like to have in order to minimize the uncertainty?