Question

Dream Homes Corporation had net earnings of $200,000 this past year and paid $80,000 in dividends...

Dream Homes Corporation had net earnings of $200,000 this past year and paid $80,000 in dividends on the company’s equity of $1,800,000. Dream Homes has 500,000 shares outstanding with a current market value of $5. What is the firm’s present value of growth opportunities if the required rate of return is

10.08 percent?

$0.77

$0.84

$0.86

$0.90

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Answer #1

Given about Dream Home corporation,

Net earning last year = $200000

Dividends = $80000

Total share outstanding = 500000

So, Earning per share EPS0 = Net earning/number of shares = 200000/500000 = $0.4

Dividend per share D0 = dividend/number of shares = 80000/500000 = $0.16

current market price P0 = $5

require rate of return r = 10.08%

So, Growth rate can be calculated using dividend growth model.

P0 = D0*(1+g)/(r-g)

=> 5 = 0.16*(1+g)/(0.1008-g)

=> 0.504 - 5g = 0.16 + 0.16g

=> g = (0.504-0.16)/5.16 = 6.67%

So, expected EPS in year 1, EPS1 = EPS0*(1+g) = 0.4*(1+0.0667) = $0.4267

So, present value of growth opportunity = P0 - EPS1/r = 5 - 0.4267/0.1008 = $0.77

Option A is correct.

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