USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
An analyst wishes to estimate the share price for Ashley Corporation. The following information is made available:
Estimated profit margin = 15%
Total asset turnover = 2
Financial leverage = 1.2
Estimated dividend payout ratio = 75%
Required rate of return = 14%
Estimated EPS = $2.50
-Refer to Exhibit 9.5. Calculate the firm's estimated share price.
A) 57.5
B) 37.5
C) 45
D) 32.75
E) 75

Question

Quizplus · Accepted Answer

The estimated share price can be calculated using the Dividend Discount Model (DDM), which in its simplest form is $ P_0 = \frac{D_1}{r - g} $, where $ P_0 $ is the current share price, $ D_1 $ is the dividend next year, $ r $ is the required rate of return, and $ g $ is the growth rate. The growth rate can be calculated using the Sustainable Growth Rate (SGR) formula, which is $ g = ROE \times (1 - dividend\ payout\ ratio) $. The Return on Equity (ROE) can be calculated using the DuPont formula: $ ROE = Profit\ Margin \times Total\ Asset\ Turnover \times Financial\ Leverage = 15\% \times 2 \times 1.2 = 36\% $. Thus, $ g = 36\% \times (1 - 75\%) = 9\% $. The dividend next year, $ D_1 $, can be calculated as $ EPS \times dividend\ payout\ ratio = $2.50 \times 75\% = $1.875 $. Plugging these values into the DDM formula gives $ P_0 = \frac{$1.875}{14\% - 9\%} = \frac{$1.875}{0.05} = $37.5 $.