question archive Question 1 Investment analysts expect Warren plc's profits for the next year to be around 50 million, the highest level ever achieved by the company
Question 1 Investment analysts expect Warren plc's profits for the next year to be around 50 million, the highest level ever achieved by the company
Subject:FinancePrice: Bought3
Question 1
Investment analysts expect Warren plc's profits for the next year to be around 50 million, the highest level ever achieved by the company. However, it is believed that in future the company will not be able to achieve the high rates of return and rapid growth recorded in recent years. The management of the company recognizes that the opportunities for reinvesting earnings profitably are limited, and intends to increase the proportion of earnings paid out in dividends from 40 per cent, the payout level of recent years, to 60 per cent next year and 70 per cent the following year. The payout ratio is expected to remain at 70 per cent from year two onwards. Management believes that the investment undertaken next year should produce an average rate of return of 40 per cent, but the expected rate of return for investment in the subsequent year is lower at 25 per cent. By year three the rate of return on new investment is expected to be 15 per cent, the shareholders minimum acceptable rate of return. All the company's investment is financed by retentions. a) Determine the level of earnings, dividends, and investment in years 1, 2, and 3. b) Estimate the value of the company if it had no investment opportunities. c) Provide an estimate of the value of the company using a dividend discount model. d) Provide an estimate of the value of the company using the earnings-investment valuation model.
