Even Better Products has come out with a new and improved product. As a result,
ID: 2770078 • Letter: E
Question
Even Better Products has come out with a new and improved product. As a result, the firm projects an ROE of 30%, and it will maintain a plowback ratio of 0.30. Its projected earnings are $2 per share. Investors expect a 14% 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.)
What is the present value of growth opportunities?
(Do not round intermediate calculations. Round your answers 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.)
b.What is the present value of growth opportunities?
(Do not round intermediate calculations. Round your answers to 2 decimal places.)
c.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.)
Explanation / Answer
Answer:a
g = ROE×b = 0.30×0.30 = 0.09 = 9.0%
D1= $2(1 – b) = $2(1 – 0.30) = $1.40
P0=D1/(Ke-g)
=$1.40/(0.14-0.09)=$28
P/E=$28/$2=14 times
Answer:b PVGO=P0-Eo/K
=$28-$2/0.14=$13.71
Answer:c
g = ROE×b = 0.30×0.20 = 0.06 = 6.0%
D1= $2(1 – b) = $2(1 – 0.20) = $1.60
P0=D1/(Ke-g)
=$1.60/(0.14-0.06)=$20
P/E=$20/$2=10 times
PVGO=P0-Eo/K
=$20-$2/0.14=$5.71
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