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Ratio and Residual Income Valuation Assignment

PROBLEM 1. Using Comparables to Value DNKN and TXRH

Reassess our previous valuations for Dunkin Brands (DNKN) and Texas Roadhouse (TXRH). The valuation ratios from the six peer firms and the fundamentals for DNKN and TXRH are given below. The peer firms are Yum! Brands (YUM), McDonald's (MCD), Chipotle Mexican Grill (CMG), Domino's Pizza (DPZ), Starbucks (SBUX), and Wendy's (WEN).

 Ratio YUM MCD CMG DPZ SBUX WEN Trailing PE 14.99 22.38 67.64 40.62 17.97 9.07 Forward PE 24.37 21.95 52.64 32.54 22.70 31.72 Price/Sales 4.61 5.95 2.77 3.87 3.33 3.22 Price/Cash flow 13.26 18.28 37.11 35.43 19.76 23.94 Dividend yield % 1.73 2.39 0.00 0.81 2.12 1.92 PEG ratio 1.22 2.68 2.98 1.77 1.13 3.85 Market cap \$bil 27.20 133.10 12.50 11.50 78.90 4.10 Fundamental DNKN TXRH Trailing EPS 2.30 2.08 Forward EPS 2.73 2.40 Sales/Share 11.65 31.94 Cash flow/Share 2.99 3.19 Dividend per share 1.39 1.00 Market price \$ 67.12 63.87

Use only the information from four of the peers (YUM, MCD, SBUX, and WEN) to do the analysis below. (Delete CMG and DPZ from the set of peers).

A. Calculate the mean and median valuation ratios for the six peer firms

The following are the mean and median ratios:

 Ratio YUM MCD CMG DPZ SBUX WEN Mean = average of all the firms Median Trailing PE 14.99 22.38 67.64 40.62 17.97 9.07 28.78 20.175 Forward PE 24.37 21.95 52.64 32.54 22.7 31.72 30.99 28.045 Price/Sales 4.61 5.95 2.77 3.87 3.33 3.22 3.96 3.6 Price/Cash flow 13.26 18.28 37.11 35.43 19.76 23.94 24.63 21.85 Dividend yield % 1.73 2.39 0 0.81 2.12 1.92 1.50 1.825

B. Using the median ratios for the peer firms, calculate the indicated prices for DNKN and TXRH.

 Ratio DNKN TXRH Share price from Trailing PE 46.40 41.96 Share price from Forward PE 76.56 67.31 Share price from Price/Sales 41.94 114.98 Share price from Price/Cash flow 65.33 69.70 Share price from Dividend yield % 76.16 54.79

C. Calculate a weighted average price for DNKN and TXRH using a 0.40 weight for the indicated price from the forward PE and a 0.15 weight for the prices indicated by the other four ratios.

The weighted average price is as follows:

Weighted average price of DNKN=(.40*76.56)+(0.15*46.40)+(0.15*41.94)+(0.15*65.33)+(0.15*76.16)+(0.15*2.54)=54.06

Weighted average price of TXRH=(.40*67.31)+(0.15*41.96)+(0.15*114.98)+(0.15*69.70)+(0.15*1.83)=61.19

D. If you use the mean values of the peer ratios instead of the medians, would this increase or decrease the weighted average prices for DNKN and TXRH?

The weighted average for DNKN and TXRH would increase if mean values of the ratio is used as the mean value is greater than the median value.

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PROBLEM 2. Using the residual income model to value Hess Electrical Contractors.

Value Hess Electrical with the residual income method. You have assembled the following information and assumptions for your analysis.
• Book value per share is \$20.00
• EPS will be 20% of beginning book value for the next ten years
• Cash dividends will be 40% of EPS each year
• At the end of ten years, market price per share will be 1.8 times book value per share
• The Hess beta 0.9, the risk-free rate is 3.0%, and the equity risk premium is 5.0%

1. Prepare a table showing, for each year, the beginning and ending book values, net income per share, dividends per share, residual income, and the present value of residual income.

 0 1 2 3 4 5 6 7 8 9 10 Book Value 20 20 Net income per share 4 4 4 4 4 4 4 4 4 4 Dividend per share 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 Market price per share 36 Residual income 2.4 2.4 2.4 2.4 2.4 2.4 2.4 2.4 2.4 2.4 Present value of residual income 2.23 2.08 1.93 1.80 1.67 1.56 1.45 1.35 1.25 1.16 Rate of return 8%

2. Estimate the per share value of REM stock using the residual income model.

Per share value of REM=Book value+sum of present values of residua income
Per share value of REM=20+16.47=\$36.47

3. Estimate the per share value of REM stock using the dividend discount model.

 0 1 2 3 4 5 6 7 8 9 10 Book Value 20 20 Net income per share 4 4 4 4 4 4 4 4 4 4 Dividend per share 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 Market price per share 36 Present value of dividends 1.49 1.38 1.29 1.20 1.11 1.04 0.96 0.90 0.83 0.78 Rate of return 8%

Per share value of REM=Present value of market price+Sum of present values discounted back at 8%

Per share value of REM=36/?1+.08?^10 +10.98=17.47+10.97=\$28.45

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