Portfolio Management Problem Set

Q1. Answer all parts of this question.
This question concerns the valuation of the Royal Mail Group plc (RMG) shares.
RMG shares were issued at a £3.30 pps in October, 2013.

(a) This part of the question uses UKM data to determine the cost of capital for RMG shares. See Question 2 solution of Handout 1.
(i) Use the data on UKM earnings and the latest dividend to calculate the long run earnings, the current payout ratio and the target payout ratio.
(ii) Use the answers from (i) to calculate the growth rate of UKM dividends.
(iii)Use your answer to (ii) to forecast the next annual dividend.
(iv) Use the price at the end of March, 2013 given the growth rate, the predicted dividend from (iii) and the constant growth dividend discount model (GGM) equation to find the implied cost of capital of UKM.
(b) This part of the question values RMG shares using the GGM (DDM).
(i) Obtain the EPS series for RMG.
(ii) Use the corresponding data for RMG calculate the growth rate of RMG dividends. (use 20p as the current dividend)
Calculate the share price of RMG under the following scenarios:
(iii) Constant growth of dividends at the RMG growth rate calculated in (ii) (GGM Model). Use the rate of capitalisation obtained from part (a). Is this a reasonable answer? Explain.
(iv) Constant growth for the first three years’ dividends at the RMG rate then no growth i.e. fourth year, fifth year and all subsequent dividends the same as the third year dividend.
(v) Constant growth of the first three dividends at the RMG rate and then the fourth, fifth and subsequent dividends grow at the UKM rate calculated in (a) (ii).
(vi) Use your answers to determine if RMG shares @ £3.30 were undervalued, overvalued or fairly valued at the IPO. Give you reasoning.

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