4. Testing Services Inc. is expected to have earnings of $6 per share this com- ing...

  

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4. Testing Services Inc. is expected to have earnings of $6 per share this com- ing year. It expects earning will grow at 15% for three years. The company projects that from the third year (time 3) earnings will plateau for a period of 11 years, as at that point the firm will maximize its earnings capacity. Fol- lowing this stagnation period the company will be terminated, as its unique patent which is the source of its revenues will expire, and it will no longer be profitable to run the company. It plans to regularly reinvest 60% of the earnings and pay the rest as dividends. In the very last period (time 14) all earnings will be devoted to paying costs associated with liquidation. Conse- quently no dividends will be paid. For simplicity, assume dividends are paid once a year and that the next dividend payment is exactly one year away (i.e., at time 1). Assume that investors required rate of return on equity is 10%. 4.a Value the stock. 4.b It turns out that one of Testing Services divisions can operate as a stand alone company, as its revenues do ot rely on the patent. For legal reasons that division will be able to operate independently only when the rest of Testing Services is liquidated. It is projected that this division's earnings at the year Testing services is liquidated will be 40% of Testing services's earnings. Furthermore, once operating as an independent company the division intends to payout 70% of earnings as dividends to shareholders indefinitely; first payment at the year Testing Services is liquidated. The board is trying to use the share price of Testing Service to estimate the constant growth rate of the division. The current share price of Testing services is $48.079. Is it possible to infer the divisions growth rate. If not explain why, otherwise compute the growth rate. 4. Testing Services Inc. is expected to have earnings of $6 per share this com- ing year. It expects earning will grow at 15% for three years. The company projects that from the third year (time 3) earnings will plateau for a period of 11 years, as at that point the firm will maximize its earnings capacity. Fol- lowing this stagnation period the company will be terminated, as its unique patent which is the source of its revenues will expire, and it will no longer be profitable to run the company. It plans to regularly reinvest 60% of the earnings and pay the rest as dividends. In the very last period (time 14) all earnings will be devoted to paying costs associated with liquidation. Conse- quently no dividends will be paid. For simplicity, assume dividends are paid once a year and that the next dividend payment is exactly one year away (i.e., at time 1). Assume that investors required rate of return on equity is 10%. 4.a Value the stock. 4.b It turns out that one of Testing Services divisions can operate as a stand alone company, as its revenues do ot rely on the patent. For legal reasons that division will be able to operate independently only when the rest of Testing Services is liquidated. It is projected that this division's earnings at the year Testing services is liquidated will be 40% of Testing services's earnings. Furthermore, once operating as an independent company the division intends to payout 70% of earnings as dividends to shareholders indefinitely; first payment at the year Testing Services is liquidated. The board is trying to use the share price of Testing Service to estimate the constant growth rate of the division. The current share price of Testing services is $48.079. Is it possible to infer the divisions growth rate. If not explain why, otherwise compute the growth rate.

Answer rating: 100% (QA)

a EPS coming year 6 Dividend EPS x Payout ratio 6 x 1 06 24 D1 24 D2 ... View the full answer