Reference no: EM132240664

Question: 1. Assume a 10-year forecasting horizon. Note that ITW's Year 3 return on beginning stockholders' equity (net income divided by beginning Year 3 stockholders' equity), adjusted toexclude unusual items and their tax effects, is 9.5%. (If we add $337 × 0.65 = $219 back to net income, we get $713 + $219 = $932 of adjusted net income. Dividing that amount by $9,823 gives 9.5%.) Assume return on beginning stockholders' equity will persist at 9.5% throughout the forecasting horizon, with no additional unusual items. That is, expected net income is always equal to 0.095 multiplied by beginning-of-the-year stockholders' equity. Also assume that no additional stock issuances or repurchases are made and that dividends equal 25% of net income in each year. (This is ITW's approximate historical dividend payout ratio.) Given these assumptions, the book value of stockholders' equity at the end of Year 4 equals book value at the beginning of Year 4 plus (1 - 0.25) times Year 4 net income. Finally assume that the cost of equity capital is 9%. (This is ITW's approximate cost of equity capital.) With these relatively simple assumptions, use the abnormal earnings model to estimate the total value of Illinois Tool Works' common shares as of the end of Year 3. Ignore terminal values at the end of the 10-year forecast horizon in your calculations.

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