Question

4. 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?

5. 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.)

6. Enterprise Value (EV) was defined in Chapter 2 as EV = Market Capitalization + Debt – Cash. In 6 words, what is another way to calculate EV?

Answer 1

a) It is given that Enterprise Corp pays 80% of the Net income in dividends. This ideally means that the company has reached its saturation stage and there are no much avenues to grow. Hence, they are expected to either buy back their shares or pay their earnings as dividends to the shareholders.

b) Since only 20% of the income is available to reinvest into the company, the growth rate in the net income is expected to be less. THis is because, growth rate is directly proportional to the proportion of earnings reinvested.