Question

Linkedina has a ROE of 24% that is expected to stay like that for years 1 to 3. In year 4 the ROE is expected to change to $12 (for both new and old projects) and stay there forever. The firm's stock has just paid a dividend of 6 AUD and the retention ratio is 40%. Assume the retention ratio is held constant forever and the opportunity cost of equity capital is 12$. What is your estimate of the value of a share of the firm?

a. 48

b. 81.8

c. -45.2%

d. 60.03

e. Cannot be determined

Answer 1

1)	Growth rate = ROE*Retention ratio
	Growth rate for Years 1 to 3 = 24%*40% =				9.60%
	Growth rate from Year 4 onwards = 12%*40% =				4.80%
2)	Value of a share of the firm is the PV of expected
	dividends.
	The PV of dividends for Years 1 to 3 are calculated below:
	Year	Expected Dividend	PVIF at 12%	PV at 12%
	0	$           6.00	1.00000
	1	$           6.58	0.89286	$            5.87
	2	$           7.21	0.79719	$            5.75
	3	$           7.90	0.71178	$            5.62
	PV of dividends t1 to t3			$          17.24
	Continuing value of dividends at t3 = 7.90*1.048/(0.12-0.048) =					$      114.99
	PV of continuing value of dividends = 114.99*0.71178 =					$        81.85
	Value of the share = 17.24+81.85 =			$99.09

ALL GIVEN OPTIONS ARE WRONG.