Accounting Incremental Analysis Problems Homework Help
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1. Vikas Engineering Ltd has current dividend per share of Rs 5, which has been growing at an annual rate of 5 per cent. The company is expecting significant technical improvement and cost reduction in its operations, which would increase growth rate to 10 per cent. Vikas’ capitalisation rate is 15 per cent. You are required to calculate
(a) the value of the share assuming the current growth rate; and
(b) the value of the share if the company achieves technical improvement and cost reduction. Does the price calculated in (b) make a logical sense? Why?
2. The earnings of a company have been growing at 15 per cent over the past several years and are expected to increase at this rate for the next seven years and thereafter, at 9 per cent in perpetuity. It is currently earning Rs 4 per share and paying Rs 2 per share as dividend. What shall be the present value of the share with a discount rate of 12 per cent for the first seven years and 10 per cent thereafter?
3. Sonata Company has no investment opportunities. It expects to earn cash earnings per share of Rs 10 perpetually and distribute entire earnings as dividends to shareholders.
(a) What is the value of the share if shareholders’ opportunity cost of capital is 15 per cent?
(b) Suppose the company discovers an opportunity to expand its existing business. It estimates that it will need to invest 50 per cent of its earnings annually for ten years to produce 18 per cent return. Management does not foresee any growth after this ten-year period. What will be Sonata’s share price if shareholders’ opportunity cost of capital is 15 per cent?
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4. A prospective investor is evaluating the share of Ashoka Automobiles Company. He is considering three scenarios. Under first scenario the company will maintain to pay its current dividend per share without any increase or decrease. Another possibility is that the dividend will grow at an annual (compound) rate of 6 per cent in perpetuity. Yet another scenario is that the dividend will grow at a high rate of 12 per cent per year for the first three years; a medium rate of 7 per cent for the next three years and thereafter, at a constant rate of 4 per cent perpetually. The last year’s dividend per share is Rs 3 and the current market price of the share is Rs 80. If the investor’s required rate of return is 10 per cent, calculate the value of the share under each of the assumptions. Should the share be purchased?
5. A company’s share is currently selling at Rs 60. The company in the past paid a constant dividend of Rs 1.50 per share, but it is now expected to grow at 10 per cent compound rate over a very long period. Should the share be purchased if required rate of return is 12 per cent?
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