Question

Beagle Beauties engages in the development, manufacture, and sale of a line of cosmetics designed to make your dog look glamorous. Below you will find selected information necessary to compute some valuation estimates for the firm. Assume the values provided are from year-end 2015. Also assume that the firm’s equity beta is 1.40, the risk-free rate is 2.75 percent, and the market risk premium is 7 percent.

Dividends per share	$	2.04
Return on equity		9.50	%
Book value per share	$	17.05

	Earnings			Cash Flow			Sales
2015 value per share	$	5.00		$	6.60		$	25.65
Average price multiple		13.10			9.42			2.36
Forecasted growth rate		13.48	%		11.41	%		7.34	%

The sustainable growth rate is 5.624 percent, and the required return is 12.55 percent. Use the clean surplus relationship to calculate the share price for Beagle Beauties with the residual income model.

Answer 1

Computation of cost of equity is as follows:

Cost of Equity = Risk free rate + ( Beta x Market risk Premium)
Cost of Equity = 2.75 + (1.60 x 7)

Cost of Equity = 2.75 +11.2

Cost of Equity = 13.95

Computation of share price is as follows:

Share Price = Book value of share + (Return on equity - Cost of equity)/(Cost of equity- Growth rate)(Book value per share)

Share Price = 17.05 + (9.5-13.95)/(13.95 - 11.41)(17.05)

Share Price = 17.05 +(-4.45)/(2.54) (17.05)

Share Price = -12.82

So, the share price under residual model is $12.82