Question

HMW # 2 Chapter 13

Sisters Corp expects to earn $7 per share next year. The firm’s ROE is 15% and its plowback ratio is 50%. If the firm’s market capitalization rate is 10%.

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

Price            $

b. Calculate the price with no growth.

Price            $

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

PVGO            $

Answer 1

Part a. In order to calculate the value of share using constant growth dividend discount model, we first need to calculate the growth rate of dividends.

Sustainable Growth rate = ROE * Retention Ratio = 15% * 50% = 7.5%

D₁ = EPS * (1 - Retention rate) = $7 * 50% = $3.50

According to Constant growth dividend discount model,

Value of Share = $3.50/(10% - 7.5%) = $140--> Answer top option a

Part b & c. Value of share = Price of share with no growth + PV of growth opportunities.

Price of Share without growth = D₁/r = $3.50/10% = $35 --> Answer top option b

=> Present Value of Growth Opportunities = Value of Share - Price of Share without growth = $140 - $35 = $105 --> Answer top option c