Even Better Products has come out with a new and improved product. As a result,

Question

Even Better Products has come out with a new and improved product. As a result, the firm projects an ROE of 20%, and it will maintain a plowback ratio of 0.30. Its projected earnings are $2 per share. Investors expect a 13% 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 15% of its earnings? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

  P/E ratio

  PVGO

$

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Solution :

ROE

20%

RETENTION RATIO (b)

30%

expected return (Ke)

13%

EPS

2.00

g=ROE*b

6.00%

dividend = 2*(1-.30)

1.4

P0 = D1/(Ke-g)

              20.00

1.4/(.13-.06)

P/E ratio= MPS/EPS=20/2

10

b.PVGO = P0 - (EPS/Ke)

                 4.62

20-(2/.13)

WHAT IS c..

Even Better Products has come out with a new and improved product. As a result, the firm projects an ROE of 20%, and it will maintain a plowback ratio of 0.30. Its projected earnings are $2 per share. Investors expect a 13% rate of return on the stock.

Explanation / Answer

c. ROE 20% RETENTION RATIO (b) 15% Expected return (Ke) 13% EPS $2 g=ROE*b 3.00% Dividend = 2*(1-0.15) $1.70 P0 = D1/(Ke-g) 17 1.7/(.13-.03) P/E ratio= MPS/EPS=17/2 8.5 PVGO = P0 - (EPS/Ke) 1.62 17-(2/.13)

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