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Bad Company’s book value of equity is equal to $10,000,000, and there are 100,000 shares outstanding....

Bad Company’s book value of equity is equal to $10,000,000, and there are 100,000 shares outstanding. The company achieves and will achieve a constant 20% return on equity, and will pay out 40% of earnings in the form of dividends. Show all formulas and work.

  1. What are expected earnings per share?
  2. What is the expected dividend?
  3. What is the plowback ratio?
  4. What is the growth rate of equity?
  5. You expect the price of a share of Bad Company stock to equal $120 in a year. Assuming a 10% discount rate, what is the stock’s intrinsic value?

Solutions

Expert Solution

Expected Net Income = Total Equity*Return on Equity

= 10,000,000*20%

= $2,000,000

Earnings per share = Net Income/Number of shares

= 2,000,000/100,000

= $20 per share

Expected Dividend = Net Income*Payout ratio

= 2,000,000*40%

= $800,000

i.e. $8 per share

plowback ratio = 1 - Payout ratio

= 1-40%

= 60%

Growth rate = ROE*Plowback ratio

= 20%*60%

= 12%

Intrinsic value = Expected Dividend/(Required return - growth rate)

= 8/(10%-12%)

= not defined

jeff jeffy answered 2 years ago
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