A. Here is the pro forma using a required return of 10%.

a. Here is the pro forma using a required return of 10%. 2004 2005 2006 EPS 1.71 1.96 DPS (dividend payout 50%) 0.86 0.98 BPS 10.47 11.32 12.30 RE (10%) 0.663 0.828 The value is calculated as follows, with a 4% growth rate in the continuing value: = $23.62 b. The first building block is the book value = $10.47 The second component is the addition to book value if there is no growth, and is calculated as: = 8.13 The third (growth) component plugs to 17.40 the market price Market price 36.00 The three components are diagramed as follows: c. Reverse engineer the model: The solution is g = 1.0698, or approximately a 7% growth rate. d. For 2007: Earnings2007 = (Book value2006 × 0.10) + Residual Earnings2007 Residual earnings2007 = 0.828 × 1.0698 = 0.886 Thus, Earnings2007 = (12.30 × 0.10) + 0.886 = $2.116 per share EPS growth rate for 2007 = 2.116/1.96, which is a 7.96% growth rate For 2008: Earnings2008 = (Book value2007 × 0.10) + Residual Earnings2008 Book value2007 = 12.30 + 2.116 – 1.058 = 13.358 (The dividend is 50% of earnings) Residual earnings2008 = 0.886 × 1.0698 = 0.948 Thus, Earnings2008 = (13.358 × 0.10) + 0.948 = $2.284 per share Earnings growth rate for 2008 = 2.284/2.2116, which is a 7.94% growth rate

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