Novak Ltd expects its new tennis racquet will give it a significant first mover advantage in...

       

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Novak Ltd expects its new tennis racquet will give it a significant first mover advantage in the market and that is expected to provide growth in earnings per share of 400% within the coming year, and 75% growth in each of the subsequent 3 years. After that time, it is expected competitors will have developed and brought to market similar products with the result that Novak would expect earnings growth to drop back to its normal level of 3% per year forever. Its cash dividend was 10 cents per share last year and is expected to remain at that amount for each of the next 5 years as the company builds its retained earnings to finance research and development. In the sixth year, it is expected shareholders will be rewarded with a payout ratio that will be 80% of the earnings per share, and the payout ratio is expected to remain at that level forever. The required rate of return on Novak Ltd's ordinary shares is 20% per year and the latest earnings per share was 25 cents. Required: (a) Calculate the price that Novak Ltd ordinary shares should be selling for in the market, assuming Novak's growth projections are accurate. (4 marks) (b) Novak's Board of Directors is concerned that the Marketing Department's earnings growth projections, as a result of the new product, might be too optimistic in the first four years. The Board is in favour of a more conservative approach and recommends the growth rates should be half (i.e. reduced by 50%) of the Marketing department's projections before growth returns to its normal 3% level. Calculate the price that Novak Ltd ordinary shares should be selling for in the market, using the new, more conservative growth projections. Novak Ltd expects its new tennis racquet will give it a significant first mover advantage in the market and that is expected to provide growth in earnings per share of 400% within the coming year, and 75% growth in each of the subsequent 3 years. After that time, it is expected competitors will have developed and brought to market similar products with the result that Novak would expect earnings growth to drop back to its normal level of 3% per year forever. Its cash dividend was 10 cents per share last year and is expected to remain at that amount for each of the next 5 years as the company builds its retained earnings to finance research and development. In the sixth year, it is expected shareholders will be rewarded with a payout ratio that will be 80% of the earnings per share, and the payout ratio is expected to remain at that level forever. The required rate of return on Novak Ltd's ordinary shares is 20% per year and the latest earnings per share was 25 cents. Required: (a) Calculate the price that Novak Ltd ordinary shares should be selling for in the market, assuming Novak's growth projections are accurate. (4 marks) (b) Novak's Board of Directors is concerned that the Marketing Department's earnings growth projections, as a result of the new product, might be too optimistic in the first four years. The Board is in favour of a more conservative approach and recommends the growth rates should be half (i.e. reduced by 50%) of the Marketing department's projections before growth returns to its normal 3% level. Calculate the price that Novak Ltd ordinary shares should be selling for in the market, using the new, more conservative growth projections.

Answer rating: 100% (QA)

Answer a Price of Novak Ltd ordinary shares 025 x ... View the full answer