Even Better Products has come out with a new and improved product. As a result,
ID: 2717345 • Letter: E
Question
Even Better Products has come out with a new and improved product. As a result, the firm projects an ROE of 30%, and it will maintain a plowback ratio of 0.40. Its projected earnings are $2 per share. Investors expect a 16% rate of return on the stock.
At what price and P/E ratio would you expect the firm to sell? (Do not round intermediate calculations. Round your answers to 2 decimal places.)
Price:$_____
P/E Ratio:_____
What is the present value of growth opportunities? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
PVGO:$_____
c.
What would be the P/E ratio and the present value of growth opportunities if the firm planned to reinvest only 20% of its earnings? (Do not round intermediate calculations. Round your answers to 2 decimal places.)
P/E Ratio:_____
PVGO:$_____
Even Better Products has come out with a new and improved product. As a result, the firm projects an ROE of 30%, and it will maintain a plowback ratio of 0.40. Its projected earnings are $2 per share. Investors expect a 16% rate of return on the stock.
a.At what price and P/E ratio would you expect the firm to sell? (Do not round intermediate calculations. Round your answers to 2 decimal places.)
Price:$_____
P/E Ratio:_____
b.What is the present value of growth opportunities? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
PVGO:$_____
c.
What would be the P/E ratio and the present value of growth opportunities if the firm planned to reinvest only 20% of its earnings? (Do not round intermediate calculations. Round your answers to 2 decimal places.)
P/E Ratio:_____
PVGO:$_____
Explanation / Answer
a. Price = D1 / Ke - g
= 1.20 / 0.16 - 0.12
= $ 30
Working note:-
1) g = Growth = B * R [Where B = Retention ratio and R = ROE]
= 0.40 * 0.30
= 0.12 or 12%
2) D1= 2 ( 1 - 0.40) = $ 1.20
a. P/E ratio = Market price per share / Earnings per share
= 30 / 2
= 15
b. The present value of growth opportunities = 30 - 2 /0.16
= 30 - 12.5
= 17.5
c. (if the firm planned to reinvest only 20% of its earnings)
Working Notes:-
1) g = Growth = B * R [Where B = Retention ratio and R = ROE]
= 0.20 * 0.30
= 0.06 or 6%
2) D1= 2 ( 1 - 0.20) = $ 1.60
Price = D1 / Ke - g
= 1.60 / 0.16 - 0.06
= $ 16
P/E ratio = Market price per share / Earnings per share
= 16 / 2
= 8
The present value of growth opportunities = 16 - 2 /0.16
= 16 - 12.5
= 3.5
Conclusion:-
a. Price
P/E Ratio
$ 30
15
c. P/E ratio
PVGO
Price
8
$ 3.5
16
a. Price
P/E Ratio
$ 30
15
b. PVGO: $ 17.5c. P/E ratio
PVGO
Price
8
$ 3.5
16
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