Question #110 - Reading 20 Discounted Dividend Valuation

Reading: Reading 20 Discounted Dividend Valuation

PDF File: Reading 20 Discounted Dividend Valuation.pdf

Page: 44

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Shared Context

- Davidson needs to determine if the shares of Wellborn are currently undervalued or overvalued in the market relative to the shares' fundamental value. The estimated fair value of Wellborn shares, using a two-period dividend discount model (DDM), is: A) $27.69. B) $27.58. C) $25.29.

Question

As a part of her analysis, Davidson needs to calculate return on equity for both potential investments. What is last year's return on equity (ROE) for Samson shares?

Answer Choices:

A. 6.5%

B. 3.5%

C. 9.5%

Explanation

ROE can be calculated using the DuPont formula, which is: ROE = Net Income / Stockholder's Equity ROE = (net income / sales) × (sales / total assets) × (total assets / stockholders' equity) Therefore: ROE = (5,700,000 / 75,000,000) × (75,000,000 / 135,000,000) × (135,000,000 / 60,000,000) = (0.076) × (0.556) × (2.25) = 0.095 = 9.5%.

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