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3. Stock Valuation. [25 Marks] 1) Constant Growth. Company P's return on equity is 30%. Management plans to plowback 30% of all earnings into the
3. Stock Valuation. [25 Marks] 1) Constant Growth. Company P's return on equity is 30%. Management plans to plowback 30% of all earnings into the firm. Earnings this year will be $4 per share, and investors expect a 12% rate of return. a. Calculate the sustainable growth rate. Provide full details of your calculations. [1 mark] b. Calculate the stock price. Provide full details of your calculations. [3 Marks] c. Calculate the present value of growth opportunities. Provide full details of your calculations. [2 marks] d. What would the P/E ratio be? What would the P/E ratio be if the firm pays out all earnings as dividends? How do you conclude about the relationship between growth opportunities and the P/E ratio? Provide full details of your calculations and explain your answer. [4 Marks] ECO-20007 (June 2022) Page 4 of 12 2) Nonconstant Growth. Company ABC has been growing at a rate of 18% per year, and you expect this growth rate in earnings and dividends to continue for another 4 years. a. If the last dividend paid was $3, what will the next dividend be? (Assume the dividends are paid once a year.) [1 mark] b. If the discount rate is 10% and the steady growth rate after 3 years is 5%, what should the stock price be today? Provide full details of your calculations. [6 Marks] c. What is the expected dividend yield? Provide full details of your calculations. [2 marks] d. What do you expect the stock price to be one year from now? Provide full details of your calculations. [3 marks] e. Is the implied capital gain consistent with your estimate of the dividend yield and the expected rate of return? Provide full details of your calculations and explain your answer. [3 Marks]
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