## Related questions with answers

Even Better Products has come out with a new and improved product. As a result, the firm projects an ROE of 20 %, and it will maintain a plowback ratio of 0.30. Its earnings this year will be 2 dollars per share. Investors expect a 12 % rate of return on the stock.

a. At what price and P/E ratio would you expect the firm to sell?

b. What is the present value of growth opportunities?

c. What would be the P/E ratio and the present value of growth opportunities if the firm planned to reinvest only 20 % of its earnings?

Solution

Verifieda)

$\begin{equation} Growth = ROE \times Plowback \ ratio \end{equation}$

$\begin{equation} Growth = 20 \% \times 0.3 = 0.06 = 6 \% \end{equation}$

$\begin{equation} Dividend \ per \ share = Project \ Earnings \times (1-Plow back ratio) \end{equation}$

$\begin{equation} Dividend \ per \ share = 2 \times (1-0.30) =1.40 \end{equation}$

$\begin{equation} Price = \dfrac{Dividend \ per \ share}{Required Rate-Growth} \end{equation}$

$\begin{equation} Price = \dfrac{1.40}{12 \% - 6 \%} \end{equation}$

$\begin{equation} Price = 23.33 \end{equation}$

$\begin{equation} P/E \ ration = \dfrac{Price}{Earnings \ per \ share} \end{equation}$

$\begin{equation} P/E \ ration = \dfrac{23.33}{2} \end{equation}$

$\begin{equation} P/E \ ration = 11.67 \end{equation}$

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