You have recently been hired as an analyst with Triumvirate Brothers investment bank. As your first assignment, your manager has assigned you the task of examining several issues regarding Octavian Enterprises Limited (OEL), company listed on the Australian Securities Exchange (ASX). To assist you in this task the research department of the bank has gathered the following information:
• On 24 September 2008, OEL commenced trading ex-dividend. The cash value of the dividend was $1.26. The dividend was fully franked. • OEL only pays a final dividend each year. There is no interim dividend. • Consensus opinion amongst market analysts is that the EPS of OEL will grow at 12% p.a. for the next three years before reverting to the growth rate of the overall economy, which is currently forecast to be 3.5% p.a., in perpetuity. • The beta of OEL is estimated to be 1.15.
• On 24 September 2008, 10-year Commonwealth Bonds were trading at a yield of 7.25% p.a. in the marketplace. • OEL’s 12% p.a. corporate bonds make a coupon payment on a semi-annual basis, have 5 years until maturity and are currently priced at a yield 2% above the Commonwealth 10-year bond rate. A coupon payment was made on 24 September 2008. • The expected return on the market portfolio (including franking credits) is 14.5% p.a. • The company tax rate is 30%.
• OEL is 50% debt and 50% equity financed.
• OEL plans to continue to pay fully franked dividends for the foreseeable future.
i) Using the information given above, what would you have expected the share price to have been 24 September 2008?
ii) Suppose that the actual share price of OEL on 24 September was $25.43. On the basis of your answer to part (i), what would you recommend to a potential investor in OEL? Justify your recommendation.
iii) Are you confident in your recommendation for part (ii)? Explain.
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