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.