Question

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

a. Calculate the price with the constant dividend growth model. (Do not round intermediate calculations.)

Price            $ 100

b. Calculate the price with no growth.

Price            $

c. What is the present value of its growth opportunities? (Do not round intermediate calculations.)

PVGO            $

Answer 1

(a)-The price with the constant dividend growth model.

Here, we’ve Dividend in next year (D1) = $3.20 per share [$8.00 x 40%]

Dividend Growth Rate (g) = 6.00% [10% x 0.60]

Required Rate of Return (Ke) = 8.00%

Therefore, the Price of the stock using Constant Dividend Growth Model = D1 / (Ke – g)

= $3.20 / (0.08 – 0.06)

= $3.20 / 0.02

= $160.00

(b)-The price with no growth.

The price with no growth = Earnings per share in next year Required Rate of Return

= $8.00 per share / 0.08

= $100.00 per share

(c)-The present value of its growth opportunities (PVGO)

The present value of its growth opportunities = The share price with the constant dividend growth model - The price with no growth

= $160.00 per share - $100.00 per share

= $60.00 per share