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8 December, 17:44

The fi corporation's dividends per share are expected to grow indefinitely by 5% per year.

a. if this year's year-end dividend is $8 and the market capitalization rate is 10% per year, what must the current stock price be according to the ddm? current stock price $

b. if the expected earnings per share are $12, what is the implied value of the roe on future investment opportunities? (do not round intermediate calculations. round your answer to the nearest whole percent.) value of roe %

c. how much is the market paying per share for growth opportunities (that is, for an roe on future investments that exceeds the market capitalization rate) ? amount per share

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  1. 8 December, 18:08
    0
    a.)

    Dividend discount model (DDM) is used to determine the price of a stock.

    The formula is as follows;

    Price; P0 = D1 / (r-g)

    D1 = Dividend in year 1

    r = capitalization rate or required rate of return

    g = dividend growth rate

    P0 = 8 / (0.10-0.05)

    P0 = 160.

    The price of the Fi corporation's stock is therefore $160.

    b.)

    Use the formula that shows the relationship between ROE, retention rate and growth rate. It's as follows;

    g = ROE * b

    g = growth rate

    b = retention rate

    Given Earnings per Share (EPS) = $12 and dividend = $8, find dividend payout ratio first.

    retention ratio = (1 - dividend payout ratio)

    dividend payout ratio = 8/12 = 0.667 or 66.7%

    retention ratio; b = (1 - 0.667)

    b = 0.333 or 33.3%

    Plug it in the formula;

    0.05 = ROE * 0.333

    ROE = 0.05/0.333

    ROE = 0.15 or 15%

    c.)

    This question is asking for the Present Value of Growth Opportunity (PVGO)

    The formula is as follows;

    PVGO = Price - EPS1 / r

    Price = $160 (from part a)

    Expected earnings per share (EPS) = $12

    required rate of return (capitalization rate); r = 10% or 0.10 as a decimal

    PVGO = 160 - 12/0.10

    PVGO = 160 - 120

    PVGO = $40

    Therefore, the market is paying $40 per share for growth opportunities.
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