What do these analyses suggest about investing in Enron’s shares at a price of $83?

For the Enron case below, respond to the following questions. This summary of your responses should be a total of 2-5 pages in (APA format) double-spaced, single-sided, Times New Roman Font, 12 pitch, 1 inch margins, with no grammar or spelling errors; APA includes a reference page at the end. The reference pages will not be counted in the 3-5 pages. You should have at least 2 references – your book along with at least 1 other reference. You must cite your references.

In 2000, Enron enjoyed remarkable success in the capital markets. During that year, Enron’s shares increased in value by 89%, while the S&P 500 index fell by 9%. At the end of 2000, Enron’s shares were trading at roughly $83 per share, and all of the sell-side analysts following Enron recommended the shares as a “buy” or a “strong buy.” With 752.2 million shares outstanding, Enron had a market capitalization of $62,530 million and was one of the largest firms (in terms of market capital) in the United States. At year-end 2000, Enron’s book value of common shareholders’ equity was $11,470 million. At year-end 2000, Enron posted earnings per share of $1.19. Among sell-side analysts following Enron, the consensus forecast for earnings per share was $1.31 per share for 2001 and $1.44 per share for 2002, with 10% earnings growth expected from 2003 to 2005. At the time, Enron was paying dividends equivalent to roughly 40% of earnings and was expected to maintain that payout policy. At year-end 2000, Enron had a market beta of 1.7. The risk-free rate of return was 4.3%, and the market risk premium was 5.0%. (Note: The data provided in this problem, and the inferences you draw from them, do not depend on foresight of Enron’s declaring bankruptcy by the end of 2001.)


· Use the CAPM to compute the required rate of return on common equity capital for Enron.

· Use year-end 2000 data to compute the following ratios for Enron:

o (1)Market-to-book

o (2)Price-earnings (using 2000 earnings per share)

o (3)Forward price-earnings (using consensus forecast earnings per share for 2001)

· Reverse engineer Enron’s $83 share price to solve for the implied expected return on Enron shares at year-end 2000. Do the reverse engineering under the following assumptions:

o (1)Enron’s market price equals value.

o (2)The consensus analysts’ earnings-per-share forecasts through 2005 are reliable proxies for market expectations.

o (3)Enron will maintain a 40% dividend payout rate.

o (4)Beyond 2005, Enron’s long-run earnings growth rate will be 3.0%.

· What do these analyses suggest about investing in Enron’s shares at a price of $83?

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