BlueFire Limited had a book value of equity of $940,000 on the 31st December 2017. The...

  

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BlueFire Limited had a book value of equity of $940,000 on the 31st December 2017. The company has a required return on equity of 8% and $1,000,000 common shares. An analyst produced the following four-year forecast of the income statement of BlueFire Limited: Year ending Sales Operating expenses Depreciation Interest expense Income taxes Net income Dividends 31/12/2018 31/12/2019 31/12/2020 $990,000 $1,089,000 $594,000 $653,400 $100,000 $100,000 $50,000 $85,680 $199,920 $39,984 $900,000 $540,000 $100,000 $50,000 $63,000 $147,000 $29,400 $50,000 $73,800 $172,200 $34,440 31/12/2021 $1,197,900 $899,200 $100,000 $50,000 $44,610 $104,090 $104,090 Required: a) Calculate the book value of BlueFire's equity at the end of years 2018 to 2021 consistent with the above forecasts. b) Calculate the residual income of BlueFire's for each of the years 2018 to 2021 consistent with the above forecasts. c) Assuming BlueFire's return on common equity (ROCE) will remain permanently at 8% after 2021, estimate the value of Xavier's equity as at 31st December 2018. d) Assuming BlueFire's return on common equity (ROCE) will remain permanently at 8% after 2021, estimate the price-to-book ratio of BlueFire, as at 31st December 2021. e) BlueFire Limited adopts a highly conservative approach to its accounting, resulting in lower reported net income than would otherwise be the case. Discuss without calculations the effects that BlueFire's highly conservative approach has on the valuation of the company's equity obtained using the residual income model. BlueFire Limited had a book value of equity of $940,000 on the 31st December 2017. The company has a required return on equity of 8% and $1,000,000 common shares. An analyst produced the following four-year forecast of the income statement of BlueFire Limited: Year ending Sales Operating expenses Depreciation Interest expense Income taxes Net income Dividends 31/12/2018 31/12/2019 31/12/2020 $990,000 $1,089,000 $594,000 $653,400 $100,000 $100,000 $50,000 $85,680 $199,920 $39,984 $900,000 $540,000 $100,000 $50,000 $63,000 $147,000 $29,400 $50,000 $73,800 $172,200 $34,440 31/12/2021 $1,197,900 $899,200 $100,000 $50,000 $44,610 $104,090 $104,090 Required: a) Calculate the book value of BlueFire's equity at the end of years 2018 to 2021 consistent with the above forecasts. b) Calculate the residual income of BlueFire's for each of the years 2018 to 2021 consistent with the above forecasts. c) Assuming BlueFire's return on common equity (ROCE) will remain permanently at 8% after 2021, estimate the value of Xavier's equity as at 31st December 2018. d) Assuming BlueFire's return on common equity (ROCE) will remain permanently at 8% after 2021, estimate the price-to-book ratio of BlueFire, as at 31st December 2021. e) BlueFire Limited adopts a highly conservative approach to its accounting, resulting in lower reported net income than would otherwise be the case. Discuss without calculations the effects that BlueFire's highly conservative approach has on the valuation of the company's equity obtained using the residual income model.

Answer rating: 100% (QA)

a To calculate the book value of BlueFires equity at the end of each year we can use the formula Book Value of Equity Book Value of Equity previous year Net Income Dividends Using this formula we can ... View the full answer