Question $4$

Jack Brown, a sell$-$side analyst covering ABC Plc$,$ is updating his valuation estimates following the company's recent results announcement. The company is currently trading at $40$ per share. The company has just reported the annual sales per share of $42$ and book value of equity per share of $17\mathrm{.}8.$ Jack decides to use the residual income valuation model and uses the following data and assumptions:

ABC's stock's beta is $1\mathrm{.}2$ ; the risk$-$free rate is $3\%$; the return on market portfolio is $7\%.$

Jack predicts that during the first four forecast years ABC's sales will be increasing at the rate of $20\%$ per year and its net profit margin ratio will be constant at $5\%.$

He also predicts that during this four$-$year period ABC Plc will maintain a constant dividend pay$-$out ratio of $30\%.$

However, he is unable to make a concrete prediction beyond the four$-$year forecast horizon and therefore decided to estimate the value of ABC PLC under two different scenarios:

Optimistic scenario: after the four$-$year forecast horizon, ABC PIc will be able to maintain a perpetual growth rate of residual earnings of $3\%$ per year.

Pessimistic scenario: after the four$-$year forecast horizon, ABC Plc$\text{'}$s return on equity $($ROE$)$ will be equal to the company's cost of equity capital for all future years.

Assume no change in the number of shares.

Required:

Using the residual income valuation model and the information provided above generate the twelve$-$months forward price target estimates for ABC Plc stock under both scenarios. State and explain your investment recommendation under both scenarios. Please show your workings and provide explanations.

$($Total: $33\mathrm{.}3\%)$