Sisters Corp expects to earn $8 per share next year. The firm's ROE is 15% and its plowback ratio is 60%. If the firm's market capitalization rate is 10%.

a.) Calculate the price with the constant dividend growth model.

b.) Calculate the price with no growth.

c.) What is the present value of its growth opportunities?

Answers below

Explanation:

According to constant Dividend Growth Model, Dividend is expected to grow at a constant rate.

Expected Earnings next yeae = E1 = $8

ROE of the firm = 15%

Plowback Ratio = 60%

Dividend Payout Rato = 1 - Plowback Ratio = 1-60% = 40%

Thus, Expected Dividend next year = D1 = 0.4 * 8 = $3.2

Growth of the Firm = g = ROE * Plowback Ratio = 15% * 60% = 9%

Market Capitalisation Rate = k = 10%

a) Price of the share using constant dividend growth model = D1 / (k - g) = 3.2 / (10% - 9%) = 3.2 / 0.01 = $320

b) Price with no growth will be the price where company pays out all the earnings as dividend and does not retain or plowbacka anything thus making growth = 0%

Thus, price with no growth = E1 / k = 8 / 0.1 = $80

c) Price of the share using constant dividend growth model = Price with no growth + Present Value of Growth Opportunities (PVGO)

Hence, 320 = 80 + PVGO

PVGO = 320 - 80 = $240

Thus, Present Value of Growth Opportunities = $240