Question

On January 1, Year 1, you are considering the purchase of Nico Enterprises' common stock. Based on your analysis of Nico Enterprises, you determine the following:
1. Book value at January 1, Year 1, is $50 per share.
2. Predicted net income per share for Year 1 through Year 5 is $8, $11, $20, $40, and $30, respectively.
3. For Year 6 and continuing for all years after, predicted residual income is $0.
4. Nico is not expected to pay dividends.
5. Required rate of return (cost of capital) is 20%.

Required:
Determine the purchase price per share of Nico Enterprises' common stock as of January 1, Year 1, using the residual income valuation model (round your answer to the nearest cent).
Comment on the strengths and limitations of this model for investment decisions.



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  • CreatedJanuary 22, 2015
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