Compost Science Inc. (CSI) is in the business of converting Bostons sewage sludge into fertilizer. The business is not in itself very profitable. However, to induce CSI to remain in business, the Metropolitan District Commission (MDC) has agreed to pay whatever amount is necessary to yield CSI a 12% book return on equity. At the end of the year, CSI is expected to pay a $4 dividend. It has been reinvesting 35% of earnings.

A. Suppose CSI continues on this growth trend. What is the expected long-run rate of return from purchasing the stock at $90? What part of the $90 price is attributable to the present value of growth opportunities?

B. Now the MDC announces a plan for CSI to treat Cambridge sewage. CSIs plant will, therefore, be expanded gradually over five years. This means that CSI will have to reinvest 70% of its earnings for five years. Starting in year 6, however, it will again be able to pay out 65% of earnings in dividend. What will be CSIs stock price once this announcement is made and its consequences for CSI are known?