Question

Sisters Corp. expects to earn $4 per share next year. The firm’s ROE is 15% and its plowback ratio is 60%. If the firm’s market capitalization rate is 10%.

a. Calculate the price with the constant dividend growth model. (Do not round intermediate calculations.)

b. Calculate the price with no growth.

c. What is the present value of its growth opportunities? (Do not round intermediate calculations.)

Answer 1

a)

Plowback ratio is the ratio which estimates the amount of money a company retains after paying the dividend to the stockholders.

To calculate the stock price, the plowback ratio is the growth rate for the firm.

Here, EPS, E = $4; ROE = 15% = 0.15; Plowback Ratio = 60% = 0.60; Market capitalization rate, K = 10% = 0.10.

Dividend Payout Ratio= 100 - Plowback Ratio

= 100 - 60 = 40% or 0.4

Dividend , D = EPS * Dividend Payout Ratio

= 4 * 0.4

= $1.6

Growth , g = ROE * Plowback Ratio

= 0.15 * 0.60 =0.09

We know

Stock Price = D / (K -g)

= 1.6 / (0.10 - 0.09)

= $160

Therefore price with the constant dividend growth model is $160.

b) Stock Price = Dividend / Market Capitalization Rate

= 1.6 / 0.10

= $ 16

Therefore  price with no growth is $16.

c) Present value of its growth opportunities

Formula =

Stock Price - (EPS / Market Capitalisation Rate)

= 160 - ( 4 / 0.10)

= $120

This PVOG of  price with the constant dividend growth model.