The Rollins Metal Company is engaged in a long-term planning process and is trying to choose among several strategic options, which imply different future growth rates for the company. Management feels that the main benefit of higher growth is that it enhances the firm's current stock price. However, high growth strategies have a cost in that they generally involve considerable risk. Higher risk means that investors demand higher returns which tends to depress current stock price.

Management is having a hard time evaluating this cost-benefit trade-off because growth and risk are conceptual abstractions. In other words, it's hard to visualize how growth and risk interact with each other as well as with other things to produce stock prices. Management can, however, intuitively associate each strategy option with a growth rate and a required rate of return implied by risk.

You are a financial consultant who's been hired to help make some sense out of the situation. You feel your best approach is to develop a systematic relationship between return, growth and stock price that you can show to management visually.

Use the STCKVAL program to develop the following chart assuming the strategic options result in different constant growth rates that start immediately. The firm's last dividend was $2.35 per share.

The Price of Rollins Stock as a Function of Growth Rate

And the Return Required by Investors

Growth Rates

Can you make any general comments about the risk-return tradeoff based on your chart?

Transcribed Image Text:

6% 8% 10% 1290 Required Retums lk) 790 9% 11% 13%