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Firms A & B are identical in all respects. Neither firm has any debt. Both firms...

Firms A & B are identical in all respects. Neither firm has any debt. Both firms have invested capital of $120,000 and 6,000 shares outstanding. Their current book value and market value per share is $20.00. Both firms have a WACC and ROIC equal to 16%.

You have purchased 10 shares of Firm A and 10 shares of Firm B. Firm A pays out 100% of their earnings in the form of dividends. Firm B pays out 35% of their earnings in the form of dividends.

You sell your shares to Elliot at the end of year 3.

a) What will be each firm’s share price at the end of year 3?

b) What will be your realized rate of return for your investment in Firm A and Firm B?

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Answer #1

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Rate of Return A = 48%

Rate of Return B = [(26.91+ 1.12+ 1.12*(1.104)+ 1.12*(1.104)2)-20]/20
= 53.16%

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