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A Series of Forecasting Problems

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An analyst presents you with a following pro forma (in millions of dollars) that gives her forecast of earnings and dividends for 2007 -2011. She asks you to value the $ 1,380 millions shares outstanding at the end of 2006, when common shareholder's equity stood at $4,310 million. Use a required rate of return of 10 percent in your calculations.

2007E 2008E 2009E 2010E 2011E
Earnings 388.00 570.00 599.00 629.00 660.40
Dividends 115.00 160.00 349.00 367.00 385.40

a. Forecast book value, return on common equity (ROCE) and residual earnings for each of the years, 2007-2011

b. Forecast growth rates for book value and growth in residual earnings for each of the years, 2008-2011.

2. A share traded at $26 at the end of 2006 with a price to book ratio of 2.0. Analysts are forecasting earnings per share of 2.60 for 2007. The required equity return is 10 percent. What is growth in residuals earnings that the markets expect for 2007 and beyond?

3. The following are earnings and dividends forecasts made at the end of 2006. The firm has a required equity return of 10 percent.

2007 2008 2009
EPS 3.00 3.60 4.10
DPS 0.25 0.25 0.30

a. Forecast the ex-dividend earnings growth rate and the cum-divided earnings growth rate for 2008 and 2009.

b. Forecast abnormal earnings growth for 2008 and 2009.

c. Calculate the normal forward P/E for this firm.

d. Based on you forecast, do you think that this firm will have a forward P/E greater than the normal P/E. Why?

4. In early 2003, analysts were forecasting earnings for General Motors Corporation of 4.62 per share for 2003 and 6.77 for 2004. GM was expected to pay a dividend of $ 2.00 per share in 2003. Use a required rate of return of 12 percent in the calculations below

a. Calculate cum-dividend earnings and the cum-dividend earnings rates and the cum-dividend earnings growth rate forecasted for 2004.
b. Calculate forecasted abnormal earnings growth for 2004.
c. GM was trading at $39 in early 2003. Calculate the forward P/E that the market was giving this stock. Also, calculate the PEG ratio that evaluates the forward P/E. What does the PEG ratio suggest?

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Solution Summary

This tutorial provides guidelines on how to solve problems on forecasting.

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1. Given that,
Value of shares outstanding=$1,380 million
Value of shareholder's equity=$4,310 million
(a)
2007E 2008E 2009E 2010E 2011E
Earnings 388.00 570.00 599.00 629.00 660.40
Dividends 115.00 160.00 349.00 367.00 385.40
Income left after Dividend 273.00 410.00 250.00 262.00 285.00
Book Value 4,310+$273 =$4,583 $4,583+$410 =$4,993 $4,993+$273 =$5,266 $5,266+$273 =$5,539 $5,539+$273 =$5,812
Return on common equity $388/$4,583 =0.0847 $570/$4,993 =0.1141 $599/$5,266 =0.1137 $629/$5,539 =0.1136 $660/$5,812 =0.1136
Residual earning $388-($1,380*10%) =$250 $570-($1,380*10%) =$432 $599-($1,380*10%) =$461 $629-($1,380*10%) ...

Solution provided by:
Jayant Kumar, MBA
Education
  • MBA, Indian Institute of Finance
  • Bsc, Madras University
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