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

question 5

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 8 percent.Assume that the analyst forecasts that the firm will earn ROCE of 14 percent until year 2016,when the firm will start earning ROCE equal to 8 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.
$\begin{array}{lllllll}&&&\text { Cumulative}&\text { Residual}&&\text { PV of Residual}\\&&&\text { Book Value } & \text { ROCE times } & \text { Present } & \text { ROCE times } \\&\text { Expected}&\text { Residual}&\text { Growth Factor } & \text { Cumulative } & \text { Value } & \text { Cumulative } \\\text { Year }&\text { ROCE}&\text { ROCE}&\text { to Year t-1 } & \text { Growth } & \text { Factor } & \text { Growth } \\\hline 2011 & 0.14 & & && 0.9259 &\\2012 & 0.14 & & && 0.8573 & \\2013 & 0.14 & & &&0.7938 & \\2014 & 0.14 && & & 0.7350 &\\2015 & 0.14 & & & & 0.6806 & \\2016 & 0.08 & & & & 0.6302 & \\&&&&&\text {V/B Ratio =}& \\\end{array}$

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