This question has been asked before, but the calculated answer was incorrect. Pl

Question

This question has been asked before, but the calculated answer was incorrect.  Please do not copy and paste the previous calculation.

Frisker Motors is expected to have earnings of $6.00 per share at the end of the next year (date 1). Frisker will retain 75 percent of its earnings at the end                    of each of the next three years to finance new investments having a rate of return on equity ROE of 28 percent. Beginning with the end of year four and                    continuing forever after, Frisker plans to increase its dividend payout to 60 percent of earnings. Assuming that Frisker has a required rate of return of 12.5                    percent and that the long-run expected ROE for Frisker's new investments is 18.75 percent, determine the value of shares in Frisker Motors.

Explanation / Answer

D1 = 6*25% = 1.5

Retained earning = 4.5 which fetches earning of 4.5*ROE = 4.5*28% = 1.26 the following year, so E2 = 6+1.26 = 7.26

D2 = 7.26*25% = 1.815

Retaining earning in yr 2 = 7.26*75% = 5.445 which fetches earning of 5.445*ROE = 5.445*28% = 1.5246 the following year, so E3 = 7.26+1.5246 = 8.7846

D3 = 8.7846*25% = 2.19615

Retaining earning in yr 3 = 8.7846*75% = 6.58845 which fetches earning of 6.58845*ROE = 6.58845*28% = 1.844766 the following year, so E4 = 8.7846+1.844766 = 10.62937

D4 = 10.62937*60% = 6.37762

Long term growth rate = retention rate*ROE = 40%*18.75% = 7.5%

Price at end of 3 years = D4/(r-g) = 6.37762 / (12.5%-7.5%) = 127.5524

Price now = D1/(1+r) + D2/(1+r)^2 + D3/(1+r)^3 + P3/(1+r)^3 = 1.5/1.125 + 1.815/1.125^2 + 2.19615/1.125^3 + 127.5524/1.125^3 = 93.89

Hope this detailed working helped ! Let me know in case of any queries.

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