Question

Unless stated otherwise, interest is compounded annually, and payments occur at the end of the period. Face value for bonds is $1000.

6. (10) Ginger Energy expects to have earnings per share (EPS) of $1.15 next year. They have a retention rate of 26% and their return on equity (ROE) is 15%.

a. If the investors’ required return (cost of capital) is 7.9%, find the current stock price.

b. Is Ginger Energy reinvesting their money wisely (are they increasing shareholder wealth with their project selection)? Explain.

Answer 1

EPS	1.15
Retention rate	26%
Dividend distribution	74%
Dividend distribution-D1	0.851
ROE	15%
Growth rate	Retention * ROE
Growth rate	=0.26*0.15
Growth rate	3.900%
Cost of capital-Ke	7.900%
Price=	D1/(Ke-g)
Price=	0.851/(7.9%-3.9%)
Price=	21.275
Expected return of investor is 7.9% and company is able to make return of 15%
on its investment and hence company is able to make more return on money if reinvested in business
The more EPS will be generated if money is reinvested which will incease the dividend in subsequent period and
accordingly will increase the share price so we can say that the company is increasing shareholder wealth