Question

Suppose that the consensus forecast of security analysts of your favorite company is that earnings next year will be $5.00 per share. The company plows back 50% of its earnings and if the Chief Financial Officer (CFO) estimates that the company's return on equity (ROE) is 16%. Assuming the plowback ratio and the ROE are expected to remain constant forever:

If you believe that the company's required rate of return is 10%, what is your estimate of the price of the company's stock?

*Make sure to input all currency answers without any currency symbols or commas, and use two decimal places of precision.

Answer 1

Answer:

Answer:

$250

Step-by-step explanation:

according to the constant dividend growth model

price = d1 / (r – g)

d1 = next dividend to be paid

r = cost of equity

g = growth rate

Sustainable growth rate is the rate of growth a company can afford in the long term

sustainable growth rate = plowback rate x ROE

b = plowback rate. It is the portion of earnings that is not paid out as dividends

g = 0.50 x 0.16 = 0.08 = 8%

5 / (10% – 8%)

5 / 2%

5 / 0.02 = $250

Answer 2

Answer:

Price = $125

Explanation:

The formula for the price is Price = Earnings next year * (1 - plowing ratio) / Rate of return - (Return on equity * plowing ratio)

Then, Price = 5(1-0.5) / (0.1 - 0.16*0-5) = $125