Question

EB Products has just released an improved product within its major product line. Due to this event, the firm projects an RoE of 18% and it will maintain a plowback ratio of 0.30. Its earnings this year will be $2 per share. Investors expect a 13% rate of return on the stock.

a. At what price and P/E multiple would you expect the firm to sell?

b. What is the Present value of growth opportunities?

Answer 1

a. The price is computed as follows:

= [ EPS x (1 - plowback ratio) ] / (expected return - (ROE x plowback ratio)

= [ $ 2 x (1 - 0.30) ] / (0.13 - (0.18 x 0.30) )

= $ 1.4 / 0.076

= $ 18.42105263 or $ 18.42 Approximately

PE is computed as follows:

= Price computed above / Earnings per share

= $ 18.42105263 / $ 2

= 9.21 times Approximately

b. PVGO is computed as follows:

g is computed as follows:

= plowback ratio x ROE

= 0.30 x 0.18

= 0.054

So, the PVGO will be as follows:

= [ Earnings x (1 - plowback ratio) / (rate of return - growth rate) ] - Earnings / rate of return

= [ $ 2 x (1 - 0.30) / (0.13 - 0.054) ] - $ 2 / 0.13

= $ 1.4 / 0.076 - $ 2 / 0.13

= $ 3.04 Approximately