1.Sisters Corp expects to earn $5 per share next year. The firm’s ROE is 14% and

Question

1.Sisters Corp expects to earn $5 per share next year. The firm’s ROE is 14% and its plowback ratio is 60%. If the firm’s market capitalization rate is 10%.

Calculate the price with the constant dividend growth model. (Do not round intermediate calculations.)

2. A common stock pays an annual dividend per share of $3.80. The risk-free rate is 8% and the risk premium for this stock is 2%. If the annual dividend is expected to remain at $3.80, what is the value of the stock?

1.Sisters Corp expects to earn $5 per share next year. The firm’s ROE is 14% and its plowback ratio is 60%. If the firm’s market capitalization rate is 10%.

Explanation / Answer

1.Sisters Corp expects to earn $5 per share next year. The firm’s ROE is 14% and its plowback ratio is 60%. If the firm’s market capitalization rate is 10%.

a.Calculate the price with the constant dividend growth model. (Do not round intermediate calculations.)

Growth rate = ROE* plowback ratio

Growth rate = 14%*60%

Growth rate = 8.40%

Expected Dividend = Expected EPS*(1-plowback ratio)

Expected Dividend = 5*(1-60%)

Expected Dividend = 2

Price with the constant dividend growth model = Expected Dividend/(Re-g)

Price with the constant dividend growth model = 2/(10%-8.4%)

Price with the constant dividend growth model = $ 125

b. Calculate the price with no growth.

Price with no growth = Expected EPS/Required rate

Price with no growth = 5/10%

Price with no growth = $ 50

c. What is the present value of its growth opportunities? (Do not round intermediate calculations.)

Present value of its growth opportunities = Price with the constant dividend growth model - Price with no growth

Present value of its growth opportunities = 125-50

Present value of its growth opportunities = $ 75

2. A common stock pays an annual dividend per share of $3.80. The risk-free rate is 8% and the risk premium for this stock is 2%. If the annual dividend is expected to remain at $3.80, what is the value of the stock?

Expected Rate of Return = risk free rate + risk premium

Expected Rate of Return = 8% + 2%

Expected Rate of Return = 10%

Value of the stock = Expected Annual Dividend/Expected Rate of Return

Value of the stock = 3.80/10%

Value of the stock = $ 38

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