Web Cites Research projects a rate of return of 20% on new projects. Management

Question

Web Cites Research projects a rate of return of 20% on new projects. Management plans to plow back 25% of all earnings into the firm. Earnings this year will be $6 per share, and investors expect a 15% rate of return on stocks facing the same risks as Web Cites.

a. What is the sustainable growth rate? (Round your answer to 2 decimal places.) Sustainable growth rate %

b. What is the stock price? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Stock price $

c. What is the present value of growth opportunities (PVGO)? (Round your answer to 2 decimal places.) PVGO $

d. What is the P/E ratio? (Do not round intermediate calculations. Round your answer to 2 decimal places.) P/E ratio

e. What would the price and P/E ratio be if the firm paid out all earnings as dividends? (Round your answer to 2 decimal places.) Price $ P/E ratio

Explanation / Answer

We have:

B = 25%

EPS = 6

KE = 15%

ROE= 205

Part A)

SGR = (ROE x b) / (1- ROE x b)

        = (0.20 x 0.25) / (1- 0.20 x 0.25)

       = 0.05/ (1-0.05)

       = 5.26%

Part B)

Do = EPS x (1-b)

      = 6 x (1-0.25)

      = 4.50

Price = Do x (1+g) / (Ke-g)

          = 4.50 x (1+0.0526) / (0.15 -0.0526)

          = 4.7367 / 0.0974

          = 48.63

Part C)

PVGO = Price – EPS/ Ke

           = 48.63 -6/ 0.15

                = 48.63-40

          = 8.63

Part D)

P/E ratio =price/ EPS

                   = 48.63/ 6

                   = 8.11

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