6. (Adapted from 2000 CFA Level II exam) Christie Johnson, CFA, has been assigned to analyze Sundanci. Johnson assumes that Sundanci’s earnings and dividends will grow at a constant rate of 13 percent. Tables 4-25 and Tables 4-26 provide financial statements and other information for Sundanci.

A. Calculate a justified P/E based on information in Tables 4-25 and 4-26 (on page 238)

and on Johnson’s assumptions for Sundanci. Show your work.

B. Identify, within the context of the constant dividend growth model, how each of the fundamental factors shown below would affect the P/E.

TABLE 4-25 Sundanci Actual 1999 and 2000 Financial Statements For Fiscal Years Ending May 31 (in millions, except per-share data)
Income Statement 1999 2000 Revenue $474 $598 Depreciation 20 23 Other operating costs 368 460 Income before taxes 86 115 Taxes 26 35 Net income 60 80 Dividends 18 24 Earnings per share $0.714 $0.952 Dividends per share $0.214 $0.286 Common shares outstanding 84.0 84.0 Balance Sheet 1999 2000 Current assets $201 $326 Net property, plant, and equipment 474 489 Total assets 675 815 Current liabilities 57 141 Long-term debt 0 0 Total liabilities Shareholders’ equity 618 674 Total liabilities and equity 675 815 Capital expenditures 34 38 TABLE 4-26 Selected Financial Information Required rate of return on equity 14%
Growth rate of industry 13%
Industry P/E 26 i. The risk (beta) of Sundanci increases substantially.
ii. The estimated growth rate of Sundanci’s earnings and dividends increases.
iii. The market risk premium increases.
Note: A change in a fundamental factor is assumed to happen in isolation; interactive effects between factors are ignored. Every other item of the company is unchanged.