Question

The Clipper Sailboat Company is expected to earn $2 per share next year. The company will have a return on equity of 17 percent and the company will grow 6 percent in the future. The company has a cost of equity of 14 percent. Given that information, answer the following questions.

What is the value of the company's stock? Do not round intermediate calculations. Round your answer to the nearest cent. $

What is the present value of the growth opportunity? Do not round intermediate calculations. Round your answer to the nearest cent. $

Assume that the growth rate is only 5 percent. What would the appropriate P/E multiple be for this stock? Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

growth Rate = Retention Ratio * ROE

Retention Ratio = Growth rate / ROE

= 6% / 17%

= 0.3529

Div = EPS ( 1 - Retention Ratio )

= $ 2 ( 1 - 0.3529 )

= $ 2 * 0.6471

= $ 1.2941

Part A:

Stock Price :
The price is a reflection of the company's value – what the public is willing to pay for a piece of the company. It is nothing but present value of cash flows ( Div & Sale Price of Stock at future date) from it.

P = D1 / [ Ke - g ]
D1 - Div after 1 Year
P0 - Price Today
Ke - Required Ret
g - Growth rate

Particulars	Amount
D1	$            1.2941
Growth rate	6%
Ke	14%

Price of Stock is nothing but PV of CFs from it.
Price = D1 / [ Ke - g ]
= $ 1.29 / [ 14 % - 6 % ]
= $ 1.29 / [ 8 % ]
= $ 16.18

Where
D0 = Just Paid Div
D1 = Expected Div after 1 Year
P0 = Price Today
Ke = Required Ret
g = Growth Rate

Part B:

PV of Growth Opportunity:

Prie if entire earnings are paid as div: = EPS / Disc rate

= $ 2 / 14%

= $ 14.29

PV of Growth Opportunity = Price with growth - Price without growth

= $ 16.18 - $ 14.29

= $ 1.89

Part C:

growth Rate = Retention Ratio * ROE

Retention Ratio = Growth rate / ROE

= 5% / 17%

= 0.2941

Div = EPS ( 1 - Retention Ratio )

= $ 2 ( 1 - 0.2941)

= $ 2 * 0.7059

= $ 1.4118

Stock Price :
The price is a reflection of the company's value – what the public is willing to pay for a piece of the company. It is nothing but present value of cash flows ( Div & Sale Price of Stock at future date) from it.

P = D1 / [ Ke - g ]
D1 - Div after 1 Year
P0 - Price Today
Ke - Required Ret
g - Growth rate

Particulars	Amount
D1	$            1.4118
Growth rate	5%
Ke	14%

Price of Stock is nothing but PV of CFs from it.
Price = D1 / [ Ke - g ]
= $ 1.41 / [ 14 % - 5 % ]
= $ 1.41 / [ 9 % ]
= $ 15.69

Where
D0 = Just Paid Div
D1 = Expected Div after 1 Year
P0 = Price Today
Ke = Required Ret
g = Growth Rate

PE Ratio = Price / EPS

= $ 15.69 / $ 2

= 7.845