Tasty Fry, Inc., has just invented a potato chip that looks and tastes like a French fry. Given the phenomenal market response to this product, Tasty Fry is reinvesting 50% of its earnings to expand its operations. Tasty Fry has recently declared earnings per share of 60 cents and the company pays 50% of its annual earnings as dividends. Earnings and dividends are expected to grow at a rate of 10% for the next five years, before expected competition from other companies will cause the growth rate to fall to 5% per annum. Existing investors of Tasty Fry demand a rate of return of 15% on the companys shares.

(a) What is the current share price of Tasty Fry, Inc.?

(b) If the expected competition fails to materialise in the future, how will this affect the valuation of Tasty Fry, Inc.?

(c) Discuss the price-earnings (P/E) ratio. Your answer should make reference to the calculation, interpretation, benefits, drawbacks of the measure and any other important points concerning the ratio.

(d) The constant growth model is based on unrealistic assumptions. Discuss and critique the assumptions on which Gordons dividend valuation model is based and evaluate whether these assumptions limit the usefulness of the model for stock price valuation.