Elizabeth Patrick Assignment 2.

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MBA 504: Financial Management

1. Read through the Encore International case study at the end of Chapter 7 in Principles of Managerial Finance (text) to develop ideas about the issues. 2. Then, review the questions and re-read the case to develop answers. 3. Answer all questions, clearly stating what the assumptions were as described in the case. 4. Your answers with explanations should be limited to not more than three pages.

a) Firms current book value per share n =Book value of common stock/total no. of common stock =60,000,000/2,500,000 =$24 per share

b) P/E ratio = price / earnings = 40/6.25 = 6.4 times c) 1) current required return = Rf + (Rm - Rf) = 6% +1.1(8.8 - 6) =9.08%

Note: beta is assumed as there is no information of beta in the case study.

2) New required return = Rf + (Rm - Rf) = 6% + 1.1 (10-6.6) = 9.74%

d) Ke =D1 + G P0

Elizabeth Patrick

MBA 504: Financial Management

9.74 % = 4 x100+ 0 P0 P0 = $41.07 e) 1) Ke =D1 + G P0 9.74 % = 4.24 x100+ 6% P0 P0 = $113.37 2) P0 = D1 (1+Ke) = 4.32 1.0974 + + D2 4.67 + P3 + 56.82 (1+ke) 2 (1+ke) 3 (1.0974)2 (1.0974)3

= 3.94 + 3.88 + 43 = $50.82 f) Current price of stock is $40 Price of stock in a) is $24 Price of stock in d) is $41.07 Price of stock in e) is $113.37 and $50.82 There is a difference between the above values because the there is a difference in the growth rate in part a) the stock price is based on the current book value. In part d) the value of stock is calculated by using the dividend model of growth rate and the growth is taken up to be constant. And lastly in the e) part the value of stock is calculated by taking up two growth rates for different time so the price of stock is different. The valuation of stock in e) part is the best method to calculate the price of stock as it undertakes the present value of the money and the time factor. It is most suitable because it takes into account the growth rate which is not constant.

Elizabeth Patrick

MBA 504: Financial Management