Question

Beagle Beauties engages in the development, manufacture, and sale of a line of cosmetics designed to make your dog look glamorous. Below you will find selected information necessary to compute some valuation estimates for the firm. Assume the values provided are from year-end 2015. Also assume that the firm’s equity beta is 1.40, the risk-free rate is 2.40 percent, and the market risk premium is 6.8 percent.

Dividends per share	$	3.12
Return on equity		12.00	%
Book value per share	$	17.50

	Earnings			Cash Flow			Sales
2015 value per share	$	5.90		$	7.05		$	26.10
Average price multiple		14.00			9.69			2.72
Forecasted growth rate		13.66	%		11.86	%		7.88	%

The required return is 11.92 percent. Use the clean surplus relationship to calculate the share price for Beagle Beauties with the residual income model.

Answer 1

Using residual Income model,

Residual Income Per share in Year 1 = Earnings Per Share - Required return on equity * Beginning BVPS = 5.9- 12%*17.5

= $ 3.8

Cost of Equity , r = Rf+ beta * MRP = 2.4% + 1.4*6.8%= 11.92 %

Residual Income Valuation, V = B + [(ROE-r) /(r-g) * B ]= [17.5 + 17.5*(12-11.92)/(11.92-11.86)] = $ 40.833

Answer 2

Clean surplus means the dividends are not included Clean surplus relationship is as follows: Ending book value Beginning book value +Net Income - Dividends $17.50$5.90 $3.12 $20.28 Thus, the ending book value is $20.28 Calculate the share price using residual income model. Here B is current book value and V is price of share. ROE-Required retum Required retun - Growth rate =$20.28+$20.28× 1290-11-9290 0.08 $20.28+ $20.28x_ 0.06 = $20.28+$20.28×1.334 = $20.28+ $27.05352 $47.33352 Thus, the price is $47.33352