Investors have shown great interest in the stock of Rollover Beds Corporation, because the company has been growing at an average annual rate equal to 25 percent. Jason Jackson decided to evaluate the company to determine whether he should include the stock in his investment portfolio. Jason’s analysis has led him to conclude that the current rate of growth will not end within the next 30 years. He also has determined that the appropriate required rate of return for Rollover Beds’ stock is 20 percent. Following is some other information that Jason examined:
EBIT .............. $300,000
Net income ............. $120,000
Total dividends paid ........ $ 72,000
Shares outstanding ......... 100,000
Industry P/E ratio .......... 25 ×
a. Compute the most recent dividend per share, D0. What is the dividend expected to be next year, D1?
b. Using the information provided in the problem and the result of your computation in part (a), apply the constant growth DDM to determine the current price of Rollover Beds.
c. Does your answer in part (b) make sense? Explain why you arrived at the answer you did. Given the information available, is there a more appropriate approach to estimating the price of the stock?
d. Apply the P/E ratio approach to value Rollover Beds’ stock. Compare the result of this computation to the result from part (b). Which would you consider a better estimate for the price?

  • CreatedNovember 24, 2014
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