Question

COVIDA has come out with a new and improved product. As a result, the firm projects an ROE of 25%, and it will maintain a plowback ratio of .20. Its earnings this year (EPS₁) will be $3 per share. Investors expect a 10% rate of return on the stock.

What is the present value of growth opportunities for COVIDA?

	$8.5
	$9.29
	$18
	$14.29

Answer 1

first we will calculate growth rate of covida

growth rate = ROA*plowback

= 25%*0.2 = 5%

given eps 1 is 3

so dividend is = 3(1-plowback) = 3(1-0.2) = 2.4

according to dividend discount model price of share is

= dividend1/(expected rate - growth)

= 2.4/(0.1-0.05) = 48

pv of growth oppurtunity is

= price per share - eps1/expected rate

= 48 - 3/10%

= 48-30 = 18

so option c is correct