Question

Question 6: Penn Central Electricity has existing assets that generate $4 in earnings per share. If the firm does not invest except to maintain existing assets, EPS is expected to remain constant at $4 a year. However, Penn Central can start next year with investing $1 per share a year in developing a newly discovered source for electricity generation. Each investment is expected to generate a permanent 25% return. However, the source will be fully developed by the fifth year of investing in it, which means that no more new investments are possible from year 6 onwards. Investors require an 18% rate of return. A) What is the price-earnings (P/E) ratio?

a. 5.86

b. 6.10

c. 5.64

d. 5.89

e. 6.38

B) What is the stock price if the firm would have had the same investment opportunity for 5 years, but now while maintaining a 75% dividend payout ratio during these five years?

a. $1.35

b. $23.44

c. $25.53

d. $23.57

e. $24.38

C) What is the NPVGO if the firm has the investment opportunity in perpetuity maintaining a 25% retention ratio?

a. $3.31

b. $23.57

c. $25.53

d. $22.55

e. $2.16

Answer 1