Answer to Question #189218 in Economics for Elona

Question #189218

Analyze the annual reports of Flour Mills of Fiji (2020), RB Patel Ltd (2020) and Paradise Beverages Ltd (2019) from South Pacific Stock Exchange (SPSE) and answer the following questions.


1. Calculate the share value using Dividend Discount Model, assuming dividend will grow 2% for Flour Mills of Fiji, 5% for RB Patel Ltd and 8% for Paradise Beverages constantly for the companies on their respective base year.


2. Calculate the Earnings Per Share (EPS) and the Market Capitalization for each of the companies.


3. Comment on the share value of the companies given the Dividend Growth Model (Question 1) and EPS (Question 2). 


1
Expert's answer
2021-05-05T13:54:06-0400

One of the simplest methods for valuing stocks is using the dividend discounted model. According to this model, the share price is equal to the value of dividends in the future, reduced to a given time period, that is, discounted. In other words, by predicting dividends for the future and discounting them, you can get the fair value of the shares for the current moment.


Based on the obtained fair share price, the investor can draw certain conclusions at the moment. So, for example, if the fair value of a share exceeds its market price, this indicates that the share is undervalued.


EPS stands for Earning Per Share, which translates from English as "earnings per share". The economic sense is as follows. The authorized capital of the company is divided into shares among shareholders. Each of them has corresponding securities on hand. Roughly speaking, the financial result that the company will receive at the end of the year will be further divided between shareholders depending on the number of securities they own. EPS provides an opportunity to estimate how much each participant will receive. The higher it is, the more profitable it is to invest in a particular company.

The indicator calculation looks like this:


EPS = (P - D) / N, where:


P is the company's net profit after taxes;


D - the amount directed to the payment of dividends to holders of preferred shares;


N is the number of ordinary shares.


The formula has one drawback: profit is a fairly conventional indicator. An enterprise can actually work successfully, receive good money that will be used to pay salaries, bonuses, and bonuses to employees, for investments, and the annual report will show a small financial result or even a loss at all.


For this reason, EPS can be calculated using the refined formula:


EPS = (CFO - D) / N, where:


CFO - cash flow from operating activities.


Thus, this formula uses a metric that is difficult to hide or significantly reduce.


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