Question
1. XYZ Inc. has expected earnings over the next year of $2/share (E[E1] = 2). The company is expected to maintain an earnings retention rate
1. XYZ Inc. has expected earnings over the next year of $2/share (E[E1] = 2). The company is expected to maintain an earnings retention rate of 40% (b = 0.4), i.e., 60% of earnings are expected to be paid out as dividends every year. The company has a beta of 2, the risk-free rate is 4% (rf = 4%), and the market risk premium is also 4% (E[rM]-rf = 4%).
- If the growth rate in earnings is expected to be 4% in perpetuity
- What is the value of the stock?
- What is the expected price a year from now?
- Whatistheexpectedholdingperiodreturnoverthenextyear?
- whatisROEjustifiesthisgrowthrate?
- whatisthepresentvalueofgrowthopportunityforthisstock?
- Ifthecurrentpriceofthestockis$18/share,whatistheimpliedgrowthrate?
- whatistheimpliedgrowthrate?
- whatistheimpliedROE?
- whatisthepresentvalueofgrowthopportunityforthisstock?
If the ROE is expected to be 15% in perpetuity
- whatistheimpliedgrowthrate?
- whatistheimpliedROE?
- whatisthepresentvalueofgrowthopportunityforthisstock?
2.XYZ Inc. is expected to pay no dividends for the next 5 years. However, at the end of the sixth year (at time 6), the company is expected to pay a dividend of $1/share. Dividends are expected to grow at 10% per year for the following 9 years (through the end of the 15th year, i.e., time 15), then to grow at 5% every year thereafter (forever). Assume the appropriate discount rate (required return) is 10%.
- What is the expected value of the stock at time 15?
- What is the expected value of the stock at time 5?
- What is the value of the stock today?
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