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 net income for Year +1 to Year +5:
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Year +1:
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$478,246
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Year +2:
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$491,882
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Year +3:
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$485,568
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Year +4:
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$515,533
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Year +5:
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$554,198
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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 percent.
Required
a. Compute the value of Priority Contractors on January 1, Year +1, using the residual income valuation model. The firm expects net income to grow 5 percent annually after Year +5.
b. Compute the value of Priority Contractors on January 1, Year +1, using the divi- dend discount model. The firm will pay its first dividend in Year +6. (Hint: Solve for the dividend amount using clean surplus accounting and 5 percent growth in earn- ings and shareholders' equity in Year +6.)