Assume an Analyst Is Evaluating a Firm with $1,000 of Book

question 18

Essay

Assume an analyst is evaluating a firm with $1,000 of book value of common equity and a cost of equity capital equal to 12 percent.Assume that the analyst forecasts that the firm will earn ROCE of 18 percent until year 2015,when the firm will start earning ROCE equal to 12 percent.The company pays no dividends and will not engage in any stock transactions.Use this information to complete the following table and calculate the firm's value-to-book ratio.
$\begin{array}{lllllll}&&&\text { Cumulative}&\text { Residual}&&\text { PV of Residual}\\&&&\text { Book Value } & \text { ROCE times } & \text { Present } & \text { ROCE times } \\&\text { Expected}&\text { Residual}&\text { Growth Factor } & \text { Cumulative } & \text { Value } & \text { Cumulative } \\\text { Year }&\text { ROCE}&\text { ROCE}&\text { to Year t-1 } & \text { Growth } & \text { Factor } & \text { Growth } \\\hline 2011 & 0.18 & & & & 0.8929 & \\\hline 2012 & 0.18 & & & & 0.7972 & \\\hline 2013 & 0.18 & & & & 0.7118 & \\\hline 2014 & 0.18 & & & & 0.6355 & \\\hline 2015 & 0.12 & & & & 0.5674 & \\\hline&&&&&\text {V/B Ratio =}&\\\end{array}$

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