is it easy? Midland Semiconductor has a book value of $10.50 per share. The company’s return on equity is 20 percent, and its required return on equity is 17 percent. The dividend payout ratio is 30 percent. What is the value of the shares using a single-stage residual income model? A) $21.00. B) $31.50. C) $10.50. D) $13.36. yes, it’s almost too easy to post, isn’t it? however, i had a brain fart from overthinking and studying too long, and i couldn’t get it… don’t let it happen to you!
A
Agreed Dividend per share = $10.50*.2*.3 = $0.63 $0.63/{.17-(.2*(1-.3))} = $21
Wait, I was thinking about this and I am pretty sure I was wrong. EPS = $10.50 * .2 = $2.10 Required = $10.50 * .17 = $1.785 Residual = $2.10 - $1.785 = $0.315 g = .2 * .7 = .14 Value = ($0.315)/(.17-.14) = $10.50 So C . . . . Edit: Did I have the same brain fart?
Niblita75 Wrote: ------------------------------------------------------- > Wait, I was thinking about this and I am pretty > sure I was wrong. > > EPS = $10.50 * .2 = $2.10 > Required = $10.50 * .17 = $1.785 > Residual = $2.10 - $1.785 = $0.315 > g = .2 * .7 = .14 > > Value = ($0.315)/(.17-.14) = $10.50 > > So C . . . . > > Edit: Did I have the same brain fart? Need to add B0 to your result. so still A.
Yeah, A. All the inputs to the RI model are given except g. g = b * ROE g = 0.70 * 0.20 g = 0.14 V0 = B0 + B0((ROE-r)/(r-g)) V0 = 10.50 + 10.50((0.20-0.17)/(0.17-0.14)) V0 = 10.50 + 10.50(1) V0 = 21.00
Niblita75: I calculated it the way you did the first time. It’s the easiest and most straighforward I say A too.
P/BV = (ROE - g)/(k-g) , g = 0.7*20% = 14% P = 10.5*(20-14)/(17-14) = 21 -> A
A’s the answer. But you guys all knew that… schweser has hiredgun’s answer as theirs. i calculated it the way niblita did it the first time… hiredgun, why did you decide to go that way? i guess i just went with what was the most familiar to me once i got over my brain fart.
Crap. Well I knew my second answer didn’t seem write since it was earning 3% more than Ke. I’ll never miss this question again.
cfasf1, I just plugged numbers directly into the single stage RI model as specified by CFAI, nothing fancy. I actually like the way you and Niblita streamlined the whole thing by turning it back into a Gorden Growth Model calculation (i.e. D1/r-g). My understanding is that given consistent assumptions, the DDM, RI and FCF models will all produce the same value for a company. In this case, the company pays dividends and we’ve got it’s book value readily available so I think we’re indifferent between the Gorden Growth Model and the single-stage RI model.
yes, they produce the same answer. i guess i’m just not as used to using the RI model yet. i didn’t even think to use it. that is bad. i want to be able to look at that problem and say, hey that looks like a RI problem except they don’t provide g. let’s find g and plug. just not that natural to me yet. got til june to make it second nature. i guess i was just impressed you were able to spot that right away.
…what baffles me, though is that the residual 0.63 was not adjusted for growth i.e 0.63(1.14)/(0.17-0.14). Or is this model not right for solving it?
cfasf1, I’d attribute that to my brilliance, except that it’s actually one of the “advantages” of being a repeating candidate I suppose… The only RI question I recall from last year’s exam had to do with determining the premium over book value. Curse that question in the upper right-hand corner of the exam booklet. omoobagberume, we don’t have to increase 0.63 by g because that figure is itself already D1. We’re beginning with B0 and multiplying by ROE to determine E1, which multiplied by the payout ratio reveals D1.
Thanks, HG1…