5years Case Study

Good Essays
QUESTION 1: VALUATION OF SHARES
1.
ROE= 25%
Dividends Paid = DPS/EPS (54000/50000)/4.32 1.08/4.32 0.25 25%

Share price for Ragan is $27.36

2.

Growth for 5years = 18.75%
Growth after 5 years = 15%
Dividends
D(0)=1.08
D(1)=1.08 X 1.1875=1.2825
D(2)=1.2825 X 1.1875=1.52296
D(3)=1.52296 X 1.1875=1.8085
D(4)=1.8085 X 1.1875=2.1476
D(5)=2.1476 X 1.1875=2.5503
D(6)=2.5503 X 1.15=2.9328
Terminal Value = 2.9328/0.15 X 0.20 = $41.4
Share Price = D1/(1+r) + D2(1+r)^2 +D3(1+r)^3 + D4(1+r)^4 + (D5+V5) / (1+r)^5
= 1.2825/1.25 + 1.52296/1.25^2 + 1.8085/1.25^3 + 2.1476/1.25^4+ 2.5503+41.4/1.25^5
= $17.65
Estimated share price under Josh’s assumptions is $17.65

3.
Industry average price-earnings ratio = share price/EPS
…show more content…
pros and cons of using risk-adjusted costs of capital for individual investments?
Risks vary from project to project. The risk-adjusted cost of capital is used to help understand the risk profile of a project. The risk is typically adjusted through the factor of Beta when Capital Asset Pricing Model (CAPM) is used. Therefore, an investment project has higher risk than the risk that the overall market has, Beta >1 is used and vice versa. Beta is influenced by the nature of the business. For instance, financial institutes (e.g. Banks) have a higher Beta since they have higher leverage on their balance sheet. On the other hand, consumer goods and utilities tend to usually have lower risk, therefore, lower Beta. Risk adjusted Cost of Capital accounts for the riskiness of an individual project and is, therefore, more rational in choosing individual projects. one of the major advantage of using risk adjusted COC is that an investor gets from this approach is that it evaluates the return after accounting for the risk accompanying the investment. The risk adjusted return on capital also helps in forming a steady outlook of profitability across not only business sectors but industries as well. It provides a wider view of the projects that are to be evaluated in order to acquire maximum
…show more content…
There can be obstacles in accurately measuring the risk profile of a project. For example, not having data of other potential investments that you can compare with the investment opportunity you are planning on investing in. In addition, risk adjusted cost of capital can also be a time consuming process. In order to evaluate the risk adjusted COC for individual investment opportunity, it is required to classify an investment opportunity into a specific category and then

Related Documents

  • Decent Essays

    Consequently, an investor upon being compensated by higher expected returns would take on increased risk. If an investor who wants higher expected returns, on the other hand, they must accept more risk, which means that the exact trade-off would be realized for the investors. Moreover, to assemble an efficient portfolio, an investor would need to diversify to mitigate risks. Diversification involves taking advantage of differences in risk within one’s investments due to changes in value at different times over different directions. Therefore, a portfolio consisting of several different investments where only one of them loses value, the portfolio is better than a single investment since it loses a smaller percentage of its value.…

    • 1080 Words
    • 5 Pages
    Decent Essays
  • Decent Essays

    Thus, tangibility may be positively related with leverage. TOT also suggests a positive relationship between tangibility and leverage because collateralized debt reduces the cost of fund and thus induces firms to use more debt to get more tax shield benefit. We calculate tangibility as total fixed asset divided by total asset following previous studies (Rajan & Zingales, 1995; Jamal et al., 2011; Teker et al., 2009; and Lima, 2009).…

    • 903 Words
    • 4 Pages
    Decent Essays
  • Decent Essays

    From an investor’s point of view, some of these capitals are more important than each other. An investor should also pay close attention to how the earnings per share of stock are reported as basic or diluted. Knowing the difference can make a big difference in their investments. Separation of Paid in Capital from Earned…

    • 719 Words
    • 3 Pages
    Decent Essays
  • Decent Essays

    Historical cost accounting provide information about how well or badly managements do their duty to shareholders. Among the comparisons between fair value accounting and historical cost accounting before, the advantages of fair value accounting is more than those of historical cost accounting. In my view, I prefer balance sheet approach at fair value. Fair value accounting has many advantages which are discusses above and also is a trend under regulation. The main weakness in fair value accounting is that when market is not perfect, how to get fair value from market.…

    • 1161 Words
    • 5 Pages
    Decent Essays
  • Decent Essays

    For example, in part (a), with ρ = 0.2, the increase in portfolio risk was minimal. As a practical matter, this means that Hennessy would have to spread his portfolio among many industries; concentrating on just a few industries would result in higher correlations among the included stocks. 2. Risk reduction benefits from diversification are not a linear function of the number of issues in the portfolio. Rather, the incremental benefits from additional diversification are most important when you are least diversified.…

    • 3830 Words
    • 16 Pages
    Decent Essays
  • Decent Essays

    NPV can be calculated, but is only relevant when both projects have the same WACC value. The larger the WACC value used (when all cash flows are negative), the less negative a project’s NPV becomes (which is wrong). (C) Risk Analysis in Capital Budgeting Risk is an important consideration in the capital budgeting process. Firms should be concerned with an individual project’s risk because the acceptance of a project can affect the overall riskiness of a firm. An overly-risky project can potentially cause investors to assign a higher discount rate on the firm, which would lead to a lower stock price.…

    • 800 Words
    • 4 Pages
    Decent Essays
  • Decent Essays

    Movement Of Interest Rates

    • 1078 Words
    • 4 Pages

    However, when putting a firm in terms of its short run and its long run it becomes much easier grasp. A firm may be more profitable in the short run due to lower, more moderate interest rates being issued by lenders. Also, in the short run, a firm may charge interest to customer purchases if goods are being bought by credit cards. In turn, the firm is then able to pay some interest it owes back, while still generating a profit. On the flip side, a firm may be less profitable in the long run due to higher interest rates.…

    • 1078 Words
    • 4 Pages
    Decent Essays
  • Decent Essays

    Empirical studies have shown that the impact on concentration on a bank’s risk could be either positive or negative. Firstly, Allen and Gale (2000) argue that a less concentrated banking sector with many banks may be more prone to financial crises than a concentrated banking sector with few banks. Monopolistic banks in a concentrated banking system may enhance profit, thus reducing financial fragility by maintaining higher capital buffers (Park and Peristiani, 2007). Secondly, bank supervision will be more effective in concentrated banking system because they are relatively easier to monitor, and thus systemic crises will be less pronounced. Contrary to this is a view supported by Boyd and de Nicole (2005), who postulated that large banks can charge higher interest to their clients, who in turn need to be engaged in riskier investments to meet financing costs.…

    • 1133 Words
    • 5 Pages
    Decent Essays
  • Decent Essays

    Similarly, the optimal risky portfolio for various clients/investor can differ as a result of constraints on dividend yield, short sales, tax consideration, or other investor preferences. According to the book, few portfolios can be enough to serve the demand of the various investor. Looking upon the mutual fund industry on theoretical basis, if the optimal portfolio is similar for every investor, then the expert/professional management is less costly and also more efficient. Single management firm can provide service to the large number of investor with a small increase in administrative…

    • 1235 Words
    • 5 Pages
    Decent Essays
  • Decent Essays

    Fifo Vs Lifo Essay

    • 1501 Words
    • 6 Pages

    In the studies, Bar-Yosef et al (1995) shows that, firms with higher production costs suffer more tax disadvantages if they are using FIFO method. And for the firms with lower production costs, this tax disadvantage suffering is far less. This implies that the tax advantages from LIFO for the firms with lower production cost are not as large as the tax advantages for the less efficient firms (i.e., firms with higher changes in production…

    • 1501 Words
    • 6 Pages
    Decent Essays