Question 2 Equity Valuation (10 marks) A New Zealand-based company is involved in the development of a new device. The company has a ROE of 25% and maintains a plowback ratio of 0.40. Its forecasted earnings one year from now are $1 per share. Investors expect a 20% rate of return on its stock.

(a) Calculate the price at which this companys stock should sell according to the constant growth dividend discount model (DDM). (2 marks)

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(b) Calculate the present value of growth opportunities (PVGO) for the company stock. Explain the meaning of this value. (2 marks)

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(c) If the company planned to reinvest only 20% of its earnings, explain whether and why reducing the reinvestment rate is a good decision for the company. (2 marks)

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(d) What is the P/E ratio for the company stock? (1 mark)

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