Question

1. Enterprise Corp typically pays 80% of its net income in dividends. A. Do you believe Enterprise has [many] or [few] good investment opportunities? B. Do you expect its net income to increase at a [fast] or [slow] rate?
2. You expect Sterling Company will pay a dividend of $60 million and repurchase $90 million of its common shares next year (Year 1) with both expected to grow 6% in Year 2 and 7% in Year 3. If you expect the company to be sold for $15 billion at the end of Year 3, and you have calculated the cost of equity to be 7.6%, what do you estimate the true value of the company’s net worth to be now? (First draw a timeline. Assume all cash flows are at year-end.)

Answer 1

Answer to First Part in respect of Enterprise Corp:

A. Enterprise Corp has few good investment opportunities as its dividend payment ratio is very high.

B. Its net income will increase at slow rate as its retention ration is very low.

Answer to Second Part in respect of Sterling Company:

{All figures in $million and rounded off to 2 decimal places}
Year	Dividend payout	Earning	Repurchase of Common shares	Sale value of Company	Net payout	PVAF @ 7.6%	Present Value
A	B	C (=B/80%)	D	E	F (=C+E-B-D)	G	H
I	60.00	75.00	90.00		-75.00	0.93	-69.68
II	63.60	79.50	95.40		-79.50	0.86	-68.69
III	68.05	85.06	102.08		-85.07	0.80	-68.31
III				15000.00	15000.00	0.80	12045.00
Net-worth of Company Now =	11838.32
Assumption : Dividend payout of Sterling Company assumed to be 80%.