Question

Web Cites Research projects a rate of return of 10% on new projects. Management plans to plow back 20% of all earnings into the firm. Earnings this year will be $2 per share, and investors expect a rate of return of 4% on stocks facing the same risks as Web Cites.

a. What is the sustainable growth rate? (Enter your answer as a whole percent.)

b. What is the stock price?

c. What is the present value of growth opportunities (PVGO)?

d. What is the P/E ratio?

e. What would the price and P/E ratio be if the firm paid out all earnings as dividends?

Answer 1

a.
Sustainable growth rate = ROE * Retention ratio = 10%*20%	2%
b.
DPS = EPS*(1-Retention ratio) = 2*(1-20%)	1.6
Stock price = DPS/(Ke-g) = 1.6/(4%-2%)	80
c.
Value of no growth = EPS/Ke = 2/4%	50
PVGO = Stock price - Value of no growth = 80-50	30
d.
P/E ratio = Stock price / EPS = 80/2	40
e.
If payout ratio = 100%
DPS = EPS = 2
Stock price = DPS/Ke = 2/4%	50
P/E ratio = Stock price / EPS = 50/2	25