Part A: Valuing Shares

Your investment adviser has sent you three analyst reports (A, B and C) for a young, growing company named Millennium Tutoring. These reports depict the company as speculative, but each one poses different projections of the company’s future growth rate in earnings and dividends. All three reports show that Millennium Tutoring earned $1.50 per share in the year ended previously. There is a consensus that a fair rate of return to investors for this ordinary share is 12%, and that management expects to consistently earn a 13% return on the book value of equity (ROE = 13%).

Assignment

a. The analyst who produced report A makes the assumption that Millennium Tutoring will remain a small, regional company that, although profitable, is not expected to grow. In this case, Millennium Tutoring’ management is expected to elect to pay out 100 percent of earnings as dividends. Based on this report, what model can you use to value the ordinary shares in Millennium Tutoring? Using this model, what is the value?

b. The analyst who produced report B makes the assumption that Millennium Tutoring will enter the national market and grow at a steady, constant rate. In this case, Millennium Tutoring ’management is expected to elect to pay out 30%of earnings as dividends. This analyst discloses news that this dividend has just been committed to current shareholders. Based on this report, what model can you use to value the ordinary shares in Millennium Tutoring? Using this model, what is the value?

c. The analyst who produced report C also makes the assumption that Millennium Tutoring will enter the national market but expects a high level of initial excitement for the product that is then followed by growth at a constant rate. Earnings and dividends are expected to grow at a rate of 50 percent over the next year, 20 percent for the following two years, and then revert back to a constant growth rate of 9 percent thereafter. This analyst also discloses that Millennium Tutoring’ management has just announced the payout of 30 percent of the recently reported earnings to current shareholders. Based on this report, what model can you use to value the ordinary shares in Millennium Tutoring? Using this model, what is the value?

d. Discuss the feature(s) that drives the differing valuation of Millennium Tutoring. What additional information do you need to garner confidence in the projections of each analyst report?