Question

The Clipper Sailboat Company is expected to earn $4 per share next year. The company will have a return on equity of 18 percent and the company will grow 5 percent in the future. The company has a cost of equity of 15 percent. Given that information, answer the following questions.

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

   $  

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

   $  

3. Assume that the growth rate is only 3 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

a) Calculation of Value of Company's stock :

Growth rate = Return on Equity * (1 - payout ratio)

5% = 18% * (1 - payout ratio)

==> 1 - payout ratio = 5% / 18% = 0.277

Payout ratio = 1 - 0.277 = 0.722

Dividend = Earning Per Share * payout ratio

= $4 * 0.722

= $2.89

Value of Stock Price = Dividend in year 1 / (cost of equity - growth rate)

= $2.89 / (0.15 - 0.05)

= $2.89 / 0.10

= $28.89

b) Calculation of present Value of Growth Opportunity

Present Value of Growth Opportunity = Stock Price - (Earning in year 1 / Cost of Equity)

= 28.89 - ($4 / 0.15)

= 28.89 - 26.67

= 2.22

c) Calculation of PE ratio:

Growth rate = Return on Equity * (1 - payout ratio)

3% = 18% * (1 - payout ratio)

==> 1 - payout ratio = 3% / 18% = 0.167

Payout ratio = 1 - 0.167 = 0.833

Dividend = Earning Per Share * payout ratio

= $4 * 0.833

= $3.33

Price = Dividend in 1 year/(cost of equity - growth rate)

= $3.33 / (0.15 - 0.03)

= $3.33 / 0.12

= $27.78

P/E Ratio = Price / Earning

= 27.78 / $4

= 6.94