Question

3. Consider the following data on company Thor.

BV = Book value per share 5.10

ROE = Return on equity 18.5%

MP = Market price per share 26.29

Normal growth in EPS of 3.5%.

Required return on company Thor of 5.7%

EPS = Earnings per share 2.75

DPS = Dividends per share 1.25 (this is last year dividend or D₀ )

3A. Calculate the price to book value P/B based on the fair value estimation model.

Would you buy or sell company Thor based on your calculation in 3A. Explain.

Answer 1

- Book Value = $5.10 per share

Market price = $26.29 per share

Price to book value = $26.29/$5.10

= 5.15 times

DPS (D₀) = $ 1.25

Required return(Ke) = 5.7%

growth rate(g) = 3.5%

Assuming the Dividend payout ratio will be the same and Normal growth in EPS will appl same to DPS.

Calculating fair value of share using formula:

P₀ = D₀(1+g)/Ke-g

= 1.25(1+0.035)/(0.057-0.035)

= $ 58.81

Price as per fair value = $58.81 per share

Price to book value as per fair value = $58.81/$5.10

=11.53 times

As the fair value per share of stock as per fair value estimate is higher than market price, the share is undervalued and we should BUY share of company thor.

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