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8-8 VALUING THE EQUITY OF A STABLE-GROWTH FIRM The Emerson Electric Company (EMR) was founded in 1890 and is located in St. Louis, Missouri. The firm provides product technologies and engineering services for industrial, commercial, and con- sumer markets worldwide. The firm operates in five business segments: process man- agement, industrial automation, network power, climate technologies, and appliance and tools. The company has a lengthy history of dividend payments and steady growth. In recent years, the firm's dividend payout has averaged 40% of earnings. For 2007, firm earnings were estimated to be $5.69 a share, and on December 7, 2006, Emerson's shares were trading for $86.01, and has a price-earnings ratio of 19.26. Data for the industry, sector, Emerson, and four competitor firms are shown on page 300. a. Is Emerson's current stock price reasonable in light of its sector, industry, and com- parison firms? b. Emerson's beta coefficient is 1.27. Assuming a risk-free rate of 5.02% and a mar- ket risk premium of 5%, what is your estimate of the required rate of return for Emerson's stock using the capital asset pricing model (CAPM)? What rate of growth in earnings is consistent with Emerson's policy of paying out 40% of carn- ings in dividends and the firm's historical return on equity? Using your estimated growth rate, what is the value of Emerson's shares using the Gordon (single-stage) growth model? Analyze the reasonableness of your estimated value per share using the Gordon model. c. Based on your analysis in Problem 8-8(b), what growth rate is consistent with Emerson's current share price of $86.01? Given Levered equity beta Risk free rate (10 year us Treasury Do Markeresk premium 127 5024 600 002146204 dates med mange for 2007 Dividend payout ratio SOKKNK 2076 5-year growth rate estimate 5.69 40001 3601 10.0046 Description Market Cap Sector Industrial Goods Industry Industrial Equipment & Components Emerson Electric Co. $94 618 Parker Hannifin Corp 9818 Roper Industries Inc 4 440 Pentair Inc 3.23B Waller Industries Inc 2 198 PIE 16.606 15 900 19 276 14.150 24 665 17.943 23 537 Return on Equity 14,91% 18.40% 23 72% 18 16% 14.27% 11 56% 15 70% Long-term Price To Dividend Debt to Price to Net Profit Free Cash Yield Equity Book Value Margin Flow 1.48% 0.87 50471 5.40% 75 4811 0.649 10.11 7.90% -134 900 2 40% 0.494 4257 9.54% 65.156 1 20% 0.308 2.298 8.25% 34 392 0.50% 0,603 3.122 11.89% 232.735 1.70% 0.485 1.974 4.48% 147.667 0,30% 4036 2731 7.38% -10.682 Solution Emerson Comparison to Industry a. (Make one comment per item in answer column) P/E ROE Dividend Yield LTD to Equity Price to Book Net Profit Margin Price to Cash Flow b. Estimated cost of equity Estimated growth rate DCF Estimate of Share Price C. Imputed growth rate Impute growth rate using projected dividends using historical dividend vields