المحاسب الإداري المعتمد الجزء 2 B. Corporate Finance

Tanager: A Required Return Without a Market Price

Tanager Weather Instruments

Questions: 7 Answered:

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Question of 7 Tanager: A Required Return Without a Market Price

Tanager: A Required Return Without a Market Price Case-based question

The case

Tanager Weather Instruments is a family-owned manufacturer of automated weather stations for airports, seaports and large farms. Its shares have never traded. The family plans to sell a small block of new shares to senior engineers. The board wants an estimate of the return Tanager's shareholders require, both to support the pricing of that sale and as the cost-of-equity input to Tanager's weighted average cost of capital.

Because Tanager has no market price, its adviser has selected three listed companies with similar products, customers and financing mix (all names are fictional):

Listed peer	Trailing P/E ratio	Equity beta
Vantreth Sensing	13.5	1.05
Pellmoor Metrics	15.0	1.15
Ostervane Systems	16.5	1.40

A trailing P/E ratio is the current share price divided by earnings per share (EPS) for the most recent fiscal year.

Tanager and market data	Value
Tanager EPS for its latest completed fiscal year	$2.64
Dividend payout policy	45% of each year's EPS
Expected growth in EPS and dividends, every year indefinitely	7%
Yield on short-term government securities (risk-free rate)	4.0%
Expected return on the market portfolio	10.5%

Assumptions

Use the simple (unweighted) average of the three peers' P/E ratios and betas as Tanager's values.
Tanager's business risk and debt-to-equity mix are close to the peer average, so the average peer equity beta is used without any leverage adjustment.
Estimate Tanager's current share price (P0) as the average trailing P/E multiplied by Tanager's EPS for its latest completed fiscal year, and use that estimate as P0 in the dividend growth model.
Constant-growth dividend model: the dividend for the latest completed year (D0) is 45% of that year's EPS; the next dividend (D1) is paid one year from now; the 45% payout ratio and 7% growth rate continue indefinitely.
Rates are annual. Enter percentages in percentage points (for example, 9.4 for 9.4%). Use full precision in intermediate steps and round only the final answer.

Using CAPM and the peer-average beta, what is Tanager's estimated cost of equity? Options are rounded to one decimal place.

Answer 11.5% 11.8% 12.6% 16.6%

Using the peer-average trailing P/E ratio, estimate Tanager's current share price (P0). Enter US dollars per share rounded to two decimal places.

Answer USD per share

To 2 decimal places.

Using the constant-growth dividend model and the P/E-based price estimate as P0, what is Tanager's estimated cost of equity? Enter the rate in percentage points rounded to one decimal place (for example, enter 9.4 for 9.4%).

Answer percent

To one decimal place.

The engineers argue that, because the new shares will have no exchange listing and will be hard to resell, they should be priced to give a required return of 12.0%. Using the constant-growth dividend model with Tanager's 45% payout ratio and 7% growth rate, what trailing P/E ratio (price divided by EPS for the latest completed fiscal year) is consistent with a 12.0% required return? Enter the ratio rounded to two decimal places (for example, enter 12.34 for a P/E ratio of 12.34).

Answer times (P/E ratio)

To 2 decimal places.

CAPM rewards investors only for Risk that earns a premium risk. It measures how much of that risk a share carries with beta, which is Definition of beta . Because Tanager's beta is above 1.0, its share returns are expected to Meaning of a beta above 1.0 . If the risk-free rate rose from 4.0% to 5.0% while beta and the expected return on the market portfolio stayed the same, Tanager's CAPM cost of equity would Effect of a higher risk-free rate .

Match each symbol used in Tanager's two cost-of-equity models to its meaning. Use each meaning at most once; two meanings will not be used.

Each category is used once.

Rm − Rf

For an investor who holds Tanager shares within a well-diversified portfolio, classify each event by the type of risk it represents. Each category may be used more than once.

A firmware fault forces Tanager to recall 400 of its airport weather stations.

The central bank raises its policy interest rate by 0.75 percentage points.

Tanager's orders fall because a nationwide recession leads airports, seaports and farms to postpone equipment purchases.

The national airport authority, which buys most of the company's airport stations, switches to a rival supplier.

The marks, the correct answers and the explanations appear as soon as the answers are submitted. Unanswered questions earn no marks.

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