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Problem 1 (8 points) On January 1, 1991, you are considering the purchase of ABC Company's common share. You have collected the following information on ABC Company: 1. Book value for common share on January 1, 1991 is $13 per share. 2. Predicted net income for 1991 is $2 per share and net income is expected to increase by 10% every year through 1995. 3. ABC is expected to pay $0.5 dividends per year from 1991 to 1995. 4. After 1995, abnormal earnings will grow by 5% per year. 5. ABC's beta is 1.2. The risk-free rate of return is 6.6% and the market risk premium is 7%. You should use the CAPM model to estimate the equity cost of capital for ABC Company. Required: Using the abnormal earnings formula, compute the estimated equity value per share of ABC Company on January 1, 1991. Your answers must show the steps of computations for any credits. 1991 1992 1993 1994 1995 Beyond 1995 Book value, 1/1 Forecasted NI Dividends Book value, 12/31 13 2 -0.5 2.2 Cost of capital 2 2.2 Forecasted NI Normal earnings Abnormal earnings Discount factor Discounted AE Estimated stock price WAL MART STORES INC CISCO SYSTEMS INC beta = beta = Problem 1 (8 points) On January 1, 1991, you are considering the purchase of ABC Company's common share. You have collected the following information on ABC Company: 1. Book value for common share on January 1, 1991 is $13 per share. 2. Predicted net income for 1991 is $2 per share and net income is expected to increase by 10% every year through 1995. 3. ABC is expected to pay $0.5 dividends per year from 1991 to 1995. 4. After 1995, abnormal earnings will grow by 5% per year. 5. ABC's beta is 1.2. The risk-free rate of return is 6.6% and the market risk premium is 7%. You should use the CAPM model to estimate the equity cost of capital for ABC Company. Required: Using the abnormal earnings formula, compute the estimated equity value per share of ABC Company on January 1, 1991. Your answers must show the steps of computations for any credits. 1991 1992 1993 1994 1995 Beyond 1995 Book value, 1/1 Forecasted NI Dividends Book value, 12/31 13 2 -0.5 2.2 Cost of capital 2 2.2 Forecasted NI Normal earnings Abnormal earnings Discount factor Discounted AE Estimated stock price WAL MART STORES INC CISCO SYSTEMS INC beta = beta =