Chittenden Enterprises has 632 million shares on issue. It expects earnings at the end of the year to be $940 million. The firm's equity cost of capital is 10%. Chittenden pays out 30% of its earnings in total: 20% paid out as dividends and 10% used to repurchase shares. If Chittenden's earnings are expected to grow at a constant 4% per year, what is Chittenden's share price?

Question

Quizplus · Accepted Answer

Step 1: Calculate the total dividends and repurchases
Dividends = 940 million x 20% x 30% = $56.4 million
Repurchases = 940 million x 10% x 30% = $28.2 million
Total dividends and repurchases = $84.6 million

Step 2: Calculate the earnings growth rate
The earnings growth rate is given as 4%

Step 3: Calculate the free cash flow to equity (FCFE) in the next year
FCFE = (1 - dividend payout ratio) x (1 - repurchase ratio) x earnings
FCFE = (1 - 20%) x (1 - 10%) x $940 million = $667.2 million

Step 4: Calculate the equity value
Equity value = (FCFE / (equity cost of capital - earnings growth rate))
Equity value = ($667.2 million / (10% - 4%)) = $11,120 million

Step 5: Calculate the share price
Share price = equity value / number of shares
Share price = $11,120 million / 632 million shares = $17.60
However, we need to subtract the total dividends and repurchases from the equity value to get the value of remaining shares
Value of remaining shares = $11,120 million - $84.6 million = $11,035.4 million
Share price = value of remaining shares / number of shares
Share price = $11,035.4 million / 632 million shares = $17.44

Therefore, the answer is C) $7.44.

Chittenden Enterprises Has 632 Million Shares on Issue