Question

the firm projects an ROE of 28%, and it will maintain a plowback ratio of 0.20. Its earnings this year will be $5.0 per share. Investors expect a 16% rate of return on the stock. What price do you expect ART shares to sell for in 4 years?

Answer 1

The price is computed as shown below:

growth rate is computed as shown below:

= ROE x plowback ratio

= 0.28 x 0.20

= 5.6% or 0.056

Dividend is computed as shown below:

= Earnings per share x (1 - plowback ratio)

= $ 5 x 0.80

= $ 4

So, the current price will be computed as follows:

= Dividend / (required rate of return - growth rate)

= $ 4 / (0.16 - 0.056)

= $ 38.46153846

So, the price in 4 years will be computed as follows:

= Current price x (1 + growth rate)⁴

= $ 38.46153846 x 1.056⁴

= $ 47.83 Approximately

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