Table 3.8
RAPID GROWTH SCENARIO
2005 2006 2007 2008 2009 2010
Book value strat of year 80 92 105.8 121.7 139.9 146.9
Earnings 12 13.8 15.9 18.3 21 22
Dividends 0 0 0 0 14 14.7
Retained earnings 12 13.8 15.9 18.3 7 7.4
Book value end of year 92 105.8 121.7 140 146.9 154.3
CONSTANT GROWTH SCENARIO
2005 2006 2007 2008 2009 2010
Book value start of year 80 84 88.2 92.6 97.2 102.1
Earnings 12 12.6 13.2 13.9 14.6 15.3
Dividends 8 8.4 8.8 9.3 9.7 10.2
Retained earnings 4 4.2 4.4 4.6 4.9 5.1
Book value end of year 84 88.2 92.6 97.2 102.1 107.2
First, what should she assume about investment and growth? Mr.
Breezeway suggested two valuations,
one assuming more rapid expansion (as in the top panel of Table 3.8)
and another just projecting
past growth (as in the bottom panel of Table 3.8).
Second, what rate of return should she use? Mr. Breezeway said that 15
percent, Prairie Homes
usual return on book equity, sounded right to him, but he referred her
to an article in the
Journal of Finance indicating that investors in rural supermarket
chains, with risks similar to
Prairie Home Stores, expected to earn about 11 percent on average.
Please validate if these are appropriate.. thanks
Valuation based on constant growth scenario
Growth Rate = Return on Equity x Plowback ratio = 15% x 1/3 = 0.05 or
5%  ANSWER
Value 2000 =DIV2005/ (r-g) =$8million/15%- 5% =$8million/ 10% =
$80,000,000  ANSWER
Value per share = Value 2000 / # Common Shares Outstanding =
$80m/400,000 = $200/share 
ANSWER
Valuation based on rapid growth scenario
Plowback ratio is 1 as the entire income is reinvested for the next five years.
Valuation of the firm in 2005
Value 2005 = DIV 2010 / r-g (Assume same as in constant growth scenario)
= $14.7 / 15%- 5% = $147,000,000  ANSWER
Value 2000 = (DIV2009 + Value2005) / (1 + risk) 5 = 14m +147m /
(1+0.15) 5 = $80,050,000 
ANSWER
Value per share = $80.05 / 400,000 = $200.11/share  ANSWER
As the value per share is a higher value in reviewing the rapid-
growth scenario this would be the
preferable rate to use.
Problem K
8.9. Break-Even. Dime a Dozen Diamonds makes synthetic diamonds by
treating carbon. Each diamond can be sold for $100. The materials cost
for a standard diamond is $30. The fixed costs incurred each year for
factory upkeep and administrative expenses are $200,000. The machinery
costs $1 million and is depreciated straight line over 10 years to a
salvage value of zero.
a. What is the accounting break-even level of sales in terms of number
of diamonds sold?
b. What is the NPV break-even level of sales assuming a tax rate of 35
percent, a 10-year project life, and a discount rate of 12 percent?
PROBLEM L
8.21. A project has fixed costs of $1,000 per year, depreciation
charges of $500 a year, revenue of $6,000 a year, and variable costs
equal to two-thirds of revenues.
a. If sales increase by 5 percent, what will be the increase in pretax profits?
b. What is the degree of operating leverage of this project?
c. Confirm that the percentage change in profits equals DOL times the
percentage change in sales.
Problem O
Prairie Home Sales
2000 2001 2002 2003 2004
Book value start of year$62.70 $66.10 69 73.9 76.5
Earnings $9.70 9.5 11.8 11 11.2
Dividends $6.30 6.6 6.9 7.4 7.7
Retained earnings $3.40 2.9 4.9 2.6 3.5
Book value end of year $66.10 69 73.9 76.5 80
Table 3.8
RAPID GROWTH SCENARIO
2005 2006 2007 2008 2009 2010
Book value strat of year 80 92 105.8 121.7 139.9 146.9
Earnings 12 13.8 15.9 18.3 21 22
Dividends 0 0 0 0 14 14.7
Retained earnings 12 13.8 15.9 18.3 7 7.4
Book value end of year 92 105.8 121.7 140 146.9 154.3
CONSTANT GROWTH SCENARIO
2005 2006 2007 2008 2009 2010
Book value start of year 80 84 88.2 92.6 97.2 102.1
Earnings 12 12.6 13.2 13.9 14.6 15.3
Dividends 8 8.4 8.8 9.3 9.7 10.2
Retained earnings 4 4.2 4.4 4.6 4.9 5.1
Book value end of year 84 88.2 92.6 97.2 102.1 107.2
First, what should she assume about investment and growth? Mr.
Breezeway suggested two valuations, one assuming more rapid expansion
(as in the top panel of Table 3.8) and another just projecting past
growth (as in the bottom panel of Table 3.8).
Second, what rate of return should she use? Mr. Breezeway said that 15
percent, Prairie Home?s usual return on book equity, sounded right to
him, but he referred her to an article in the Journal of Finance
indicating that investors in rural supermarket chains, with risks
similar to Prairie Home Stores, expected to earn about 11 percent on
average.
Please validate if these are appropriate?.. thanks
Valuation based on constant growth scenario
Growth Rate = Return on Equity x Plowback ratio = 15% x 1/3 = 0.05 or 5% ? ANSWER
Value 2000 =DIV2005/ (r-g) =$8million/15%- 5% =$8million/ 10% =
$80,000,000 ? ANSWER
Value per share = Value 2000 / # Common Shares Outstanding =
$80m/400,000 = $200/share ? ANSWER
Valuation based on rapid growth scenario
Plowback ratio is 1 as the entire income is reinvested for the next five years.
Valuation of the firm in 2005
Value 2005 = DIV 2010 / r-g (Assume same as in constant growth scenario)
= $14.7 / 15%- 5% = $147,000,000 ? ANSWER
Value 2000 = (DIV2009 + Value2005) / (1 + risk) 5 = 14m +147m /
(1+0.15) 5 = $80,050,000 ? ANSWER
Value per share = $80.05 / 400,000 = $200.11/share ? ANSWER
As the value per share is a higher value in reviewing the rapid-
growth scenario this would be the preferable rate to use. |
