Question

Sisters Corp. expects to earn $6 per share next year. The firm’s ROE is 16% and its plowback ratio is 60%. If the firm’s market capitalization rate is 10%.

a. Calculate the price with the constant dividend growth model. (Do not round intermediate calculations.)

b. Calculate the price with no growth.

c. What is the present value of its growth opportunities? (Do not round intermediate calculations.)

Answer 1

(a) Calculation of share price with constant dividend growth model -

Dividend of next year= Earning per share of next year*(1-plowback ratio)

= $6*(1-.60)  

= $2.40

Dividend growth rate= plowback ratio* return on equity

=60℅*16℅

= 9.6℅

Share price= Dividend next year/Cost of equity- growth

= $2.40/10℅-9.6℅

= $ 600

(b) Calculation of share price with no growth -

Since share price is without growth, All earning will be distributed as dividend

= Dividend next year/cost of equity

= $6/10℅

= $ 60

(C) Calculation of present value of growth opportunity

= Share price with growth - Share price without growth

= $ 600 - $ 60

= $ 540