Question

Laurel Enterprises expects earnings next year of $4 per share. The company will pay out all of its earnings to investors. Its expected return on new investment (i.e., ROE) is 12%.

The required rate of return is 10%. What is the intrinsic value of the stock today?

Laurel Enterprises expects earnings next year of $4 per share. The company will retain $2.4 of its earnings to reinvest in new projects that have an expected return of 12% per year (i.e., ROE is 12%). The rest of the earnings will be paid out to its investors.

Suppose the company will keep the retention rate constant in future. What is the growth rate of earnings for its share? ______%

Following question 16

If the dividends grow at the same rate as the earnings, and the required return of the stock is 10%, what is the intrinsic value of the stock?

Following question 17

Use the same setup as 17 except that the ROE for the new projects is 9% now, what is the intrinsic value of the stock?

**Hint**: since the ROE is now lower, the dividend
growth rate will be slower than the growth in #17. You'll first
need to find the dividend growth rate and then calculate the
intrinsic value.

Answer #1

Intrinsic value of the stock =Dividend Per share/Required Rate
=4/10% =40

b) Retention ratio =Retained Earnings/Income =2.4/4 =60%

growth =ROE*Retention ratio =12%*60% =7.2%

Dividend =4-2.4 =1.6

Intrinsic Value of the stock =Dividend next year/(Required
Rate-Growth) =1.6/(10%-7.2%) =57.14

c)If ROE =9%

growth =ROE*Retention ratio =9%*60% =5.4%

Dividend =4-2.4 =1.6

Intrinsic Value of the stock =Dividend next year/(Required
Rate-Growth) =1.6/(10%-5.4%) =34.78

Laurel Enterprises expects earnings next year of $3.84 per
share and has a 50 % retention rate, which it plans to keep
constant. Its equity cost of capital is 11 %, which is also its
expected return on new investment. Its earnings are expected to
grow forever at a rate of 5.5 % per year. If its next dividend is
due in one year, what do you estimate the firm's current stock
price to be?

Laurel Enterprises had earnings last year $4 per share and has a
constant 40% retention rate. Its equity cost of capital is 10%. The
expected return on new investment is 10%. If next dividend due in
one year (i.e., one year from today), what is current stock
price?
Group of answer choices
$66.67
$16.00
$40.00
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