A Friend Tells You That You Should Buy Leclerc Company

Essay

A friend tells you that you should buy Leclerc Company stock as it is a "great deal." It is January 1, 2006 and the stock is trading at $25 per share. You obtain the financial statements for Leclerc and determine the following:

1. Book value is $12 per share as of December 31, 2005.
2. Earnings for 2005 were $4.0 per share.
3. Earnings are expected to grow at 20% for the next four years.
4. Dividend payout is 40%.
5. Residual income is expected to be zero from 2007 onwards.
6. Cost of equity capital is 15%.

Determine, using the residual income method, whether you should buy Leclerc stock as of January 1, 2006.