XYZ Inc. has been reinvesting 60% of earnings into a project that yields a return of 12%. The dividend yield is expected to be 3% next year. The current share price of XYZ Inc. is $120 / share.

1. (a)If XYZ Inc. can continue to reinvest at this rate and earn 12% on the investment, how rapidly will the earnings and dividends grow? Also, calculate the market required rate of return.

1. (b)What is the present value of the growth opportunities (PVGO) of XYZ Plc.? Comment briefly on the PVGO you obtained.

1. (c)Now XYZ Plc. announces that it will reinvest 80% of its earnings for the next 5 years. Starting in Year 6, the company will again be able to pay out 40% of its earnings. What will XYZ'sshare price be once this announcement is made?

formula sheet

Five-year discount factor at a discount rate of 10.2% 1

1. 0.907

2. 0.823

3. 0.747

4. 0.678

5. 0.615

payout ration=D/E ( D: dividend per share and E: earnings per share)

Dividend yield = D/P ( D: dividend per share P: share price)

plowback ration= 1-payout ration

g= return on equity x plowback ration

constant dividend model; P0=D/r

Dividend growth model : P0= D1/r-g

P0= EPS1/r+PVGO