Question

The FI Corporation’s dividends per share are expected to grow
indefinitely by 6% per year.

**a.** If this year’s year-end dividend is $7.00 and
the market capitalization rate is 8% per year, what must the
current stock price be according to the DDM?

**b.** If the expected earnings per share are
$21.00, what is the implied value of the ROE on future investment
opportunities? **(Round your answer to 2 decimal
places.)**

**c.** How much is the market paying per share for
growth opportunities (i.e., for an ROE on future investments that
exceeds the market capitalization rate)? **(Round your answer
to 2 decimal places.) Per share**

Answer #1

Part A:

Price as per DDM = D1 / [ Ke - g ]

= $ 7 / [ 8% - 6% ]

= $ 7 / 2%

= $ 350

Part B:

Growth Rate = Retention Ratio * ROE

Retention ratio = [ EPS - DPS ] / EPS

= [ 21 - 7 ] / 21

= 14 /21

= 0.67

ROE = 6% / 0.67

= 9%

Part C:

PVGO = Price with growth - Price without growth

When entire earnings will be distributed as div, there will be no growth rate.

Price = Div / Ke

Price without growth = $ 21 / 8%

= $ 262.5

PVGO = Price with growth - Price without growth

= $ 350 - $ 262.50

= $ 87.50

Pls do rate, if the answer is correct and comment, if any further assistance is required.

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