1. (11 points) Growth Inc. has an expected earnings of $4 per share for next year. The risk-free rate of return is 4%, and the expected return on the market portfolio is 14%. Growth Inc. has a beta of 1.2. Investors use the CAPM to compute the market capitalization rate and use the constant-growth DDM to determine the value of the stock.

1. (4 points) Assume that Growth Inc. maintains a 100% dividend payout policy, what is the most that you will pay for its stock?

2. (5 points) If Growth Inc. just discovers a new growth opportunity with an ROE of 20%. The management decides to pay out 40% of its earnings starting from the next years dividend and forever after, so that it can reinvest the rest in the growth opportunity. Suppose the growth opportunity lasts forever, what is the present value of its growth opportunity (PVGO)?

3. (2 points) What is the ROE of the growth opportunity such that PVGO of Growth Inc. is exactly zero, while everything else remain the same as in Question (2)?