Reference no: EM132753429

Equity Valuation Using the Residual Income and Dividend Discount Models. Priority Contractors provides maintenance and cleaning services to various corporate clients in New York City.

The firm has provided the following forecasts of comprehensive income for Year +1 to Year +5:

Year +1: $478,246
Year +2: $491,882
Year +3: $485,568
Year +4: $515,533
Year +5: $554,198

Total common shareholders' equity was $2,224,401 on January 1, Year +1. The firm does not expect to pay a dividend during the period of Year +1 to Year +5. The cost of equity capital is 12%.

REQUIRED

Problem a. Compute the value of Priority Contractors on January 1, Year +1, using the residual income valuation model. The firm expects comprehensive income to grow 5% annually after Year +5.

Problem b. Compute the value of Priority Contractors on January 1, Year +1, using the dividend discount model. The firm will pay its first dividend in Year +6. (Hint: Solve for the dividend amount using clean surplus accounting and 5% growth in comprehensive income and shareholders' equity in Year +6.)