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 .30. Its projected earnings are $2 per share. Investors expect a 12% 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.)

What is the present value of growth opportunities? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

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.)

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 .30. Its projected earnings are $2 per share. Investors expect a 12% rate of return on the stock.

Explanation / Answer

a.Plowback ratio = retention ratio = (1- dividend payout ratio) =0.30

Growth rate = Plowback ratio* ROE = 0.3*0.2=0.06 or 6%

Po = D1/ k-g

Dividend = EPS (1-Plowback ratio) = $2(0.7) = $1.4

Po = $1.4/0.12-0.06 = $23.33

P/E ratio = $23.33/$2 =$11.67

b. Present value of growth opportunities PVGO = Po = EPS/K = $23.33-$2/0.12= $6.66

c. P/E ratio and the present value of growth opportunities if the firm planned to reinvest only 20% of its earnings.

g= ROE*b = 0.2*0.2 =0.04 = 4%

D1 = Do (1-b) = $2(1-0.2) =$1.6

Po= D1/k-g =$1.6/0.12-0.04 = $20

P/E ratio = $20/$2 = 10

PVGO = Po- EPS/K = $20-$2/0.12 =$3.33

Related Questions

Navigate

• Browse (All)
• Browse E
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.