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

1. Calculate the total amount of earnings paid out to shareholders:
- 20% paid out as dividends = 0.2 x $940 million = $188 million
- 10% used to repurchase shares = 0.1 x $940 million = $94 million
- Total payout to shareholders = $188 million + $94 million = $282 million

2. Calculate the total amount of earnings retained in the firm:
- Retained earnings = $940 million - $282 million = $658 million

3. Calculate the growth rate factor:
- Growth rate factor = 1 / (1 + growth rate) = 1 / (1 + 0.04) = 0.9615

4. Calculate the terminal value of the firm's earnings:
- Terminal value = (retained earnings x (1 + growth rate)) / (cost of equity - growth rate) = ($658 million x 1.04) / (0.10 - 0.04) = $10,940 million

5. Calculate the total value of the firm:
- Total value of the firm = (earnings paid out / cost of equity) + terminal value = ($282 million / 0.10) + $10,940 million = $13,120 million

6. Calculate the share price:
- Share price = total value of firm / number of shares on issue = $13,120 million / 632 million shares = $20.76 per share
- However, since the company is repurchasing shares, the number of shares will decrease over time. Therefore, we need to adjust for this:
- Adjusted share price = $20.76 x (1 - 0.10) = $18.68 per share
- Adjusted share price also needs to be adjusted for the dividend payout:
- Final share price = ($18.68 - $0.20) / (1 - 0.30) = $7.44 per share

Therefore, the best choice is C.

Chittenden Enterprises Has 632 Million Shares on Issue