Question

a. MF Corp. has an ROE of 15% and a plowback ratio of 40%. If the coming year's earnings are expected to be $3 per share, at what price will the stock sell? The market capitalization rate is 12%. (Round your answer to 2 decimal places. Do not round intermediate calculations.)

Price            $

b. What price do you expect MF shares to sell for in three years? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Price            $

Answer 1

Information provided:

ROE= 15%

Plowback ratio= 40%

Market capitalization ratio= 12%

Earnings per share is computed as below:

= $3*(1- 0.40)

= $1.80

Growth rate= ROE*Retention ratio

                   = 0.15*0.40

= 0.06*100

                    = 6%

The price of the stock is calculated using the dividend discount model.

Price of the stock =D1/(r-g)

where:

D1=next dividend payment

r=interest rate

g=firm’s expected growth rate

Dividend in one year is the same as earnings per share.

Price of the stock = $1.80/ 0.12 – 0.06

                                  = $1.80/ 0.06

                                   = $30

The price at which MF shares will sell in 3 years is computed as below:

= Po*(1 + growth rate)^3

= $30*(1+ 0.06)^3

= $30*1.1910

= $35.73

Therefore, the price at which MF shares will sell in 3 years is $35.73.

In case of any query, kindly comment on the solution.