Question

Stock A has an earnings of $5 per share at year 1. The interest rate is 20%, and the return on equity is 25%. If there is no plow-back and you like to buy stock A now and hold it for two years, what is the expected return for your investment ?

Stock A has an earnings of $5 per share at year 1. The interest rate is 20%, and the return on equity is 25%. If there is a plow-back of 40%, what is the earnings per share at year two (EPS2) ?

Stock A pays a dividend of $3 per share every year. The discount rate is 10% and the return on equity is 25%. If you want to buy stock A at year 1 and hold it for 5 years, what is the price you have to pay at year 1 (P1)?

Answer 1

Question 1:

We have given earning per share = $5

Interest Rate or Discount rate = 20%

So, Price of Share = EPS / Discount Rate

= 5 / 20%

= $25

Now, We have given Return on Equity = 25%

And, If plowback ratio is zero then it means that the company is distributing all it's earning as dividends to the shareholders which refers that return on equity is actual return to the shareholders.

Expected Return = (Price Per share * Return on Equity) / Price Per share

= (25 *25%) / 25

= 6.25 /25

= 25%

So, The expected return to the shareholder is 25%.

Question 2: Stock A Earning per share = $5

Share Price = Earning / Interest rate

= 5 / 20%

= $25

Return On equity = 25%

Plowback ratio = 40%

So, Eaning Allocated to Shareholders =Return On equity * (1 - Plowback ratio)

= 25% * ( 1 - 40%)

= 15%

So, Earning at year 2 = Earning in year 1 * ( 1 + Growth allocate to shareholder)

= 5 * ( 1+ 15%)

= 5*1.15

= $5.75

So, The Earning Per share at year 2 is $5.75,

Question 3: We have given,

Dividend = $3 Per share

Interest rate or discount rate = 10%

So, Share Price = Dividend / Interest rate

= 3 / 10%

= $30

So, The share price in year 1 is $30