Even Better Products has come out with a new and improved product. As a result,
ID: 2714132 • Letter: E
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 $4 per share. Investors expect a 14% 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 10% 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 0.30. Its projected earnings are $4 per share. Investors expect a 14% rate of return on the stock.
Explanation / Answer
Solution for sub-part a:
Given Data,
ROE, r = 20%
Projected earnings, EPS = $4
Plowback ratio, b = 0.30
Expected return of investor, Ke = 14%
Calculation of Growth Rate (g) :
g = b * r
= 0.30 * 20%
= 6%
Calculation of price(P) at which firm should sell:
P = [EPS(1-b)]/[Ke-g]
= [$4(1-0.30)]/[0.14-0.06]
= $2.8/0.08
= $35
Calculation of P/E Ratio:
P/E Ratios = P/EPS
= $35/$4
= 8.75 times
Solution for sub-part b:
Calculation of PVGO:
PVGO = Price of Share with Growth – Price of Share without Growth
= [EPS(1-b)]/[Ke-g] – EPS(1-b)/Ke
= [$4(1-0.30)]/[0.14-0.06] - $4(1-0.30)/0.14
= [$2.8/0.08] – [$2.8/0.14]
= $35-$20
= $15
Solution for sub-part c:
Given Data,
ROE, r = 20%
Projected earnings, EPS = $4
Plowback ratio, b = 0.10
Expected return of investor, Ke = 14%
Calculation of Growth Rate (g) :
g = b * r
= 0.10 * 20%
= 2%
Calculation of price(P) at which firm should sell:
P = [EPS(1-b)]/[Ke-g]
= [$4(1-0.10)]/[0.14-0.02]
= $3.6/0.12
= $30
Calculation of P/E Ratio:
P/E Ratios = P/EPS
= $30/$4
= 7.5 times
Calculation of PVGO:
PVGO = Price of Share with Growth – Price of Share without Growth
= [EPS(1-b)]/[Ke-g] – EPS(1-b)/Ke
= [$4(1-0.10)]/[0.14-0.02] - $4(1-0.10)/0.14
= [$3.6/0.12] – [$3.6/0.14]
= $30 - $25.71
= $4.29
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.