Question

Aces High Airline Supply generates a rate of return of 18% on its investments and maintains a plowback ratio of 20%. It's earnings this year will be $3 per share. Investors expect 10% retun on the stock. What is the price of the company?

Answer #1

Payout Ratio = 1 - Plowback Ratio

Payout Ratio = 1 - 0.20

Payout Ratio = 0.80

Growth Rate, g = Return on Equity * Plowback Ratio

Growth Rate, g = 10.00% * 0.20

Growth Rate, g = 2.00%

Current Dividend, D0 = Current EPS * Payout Ratio

Current Dividend, D0 = $3.00 * 0.80

Current Dividend, D0 = $2.40

Expected Dividend, D1 = D0 * (1 + g)

Expected Dividend, D1 = $2.40 * 1.02

Expected Dividend, D1 = $2.448

Required Return, rs = 18%

Stock Price, P0 = D1 / (rs - g)

Stock Price, P0 = $2.448 / (0.18 - 0.02)

Stock Price, P0 = $2.448 / 0.16

Stock Price, P0 = $15.30

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