Question

a. MF Corp. has an ROE of 16% and a plowback ratio of 50%. If the coming year's earnings are expected to be $2 per share, at what price will the stock sell? The market capitalization rate is 12%. (Do not round intermediate calculations.)b. What price do you expect MF shares to sell for in 3 years?

Answer 1

Answer:

Return on equity(r) = 0.16

Plowback ratio(b) = 50 = 0.5

Earnings per share(EPS) = $2

D1 = 50% x $2 = $1

Cost of equity(Ke) = 0.12

Growth rate(g) = b x r

                        = 0.5 x 0.16

                        = 0.08 = 8%

Current market price(Po) = D1/Po + g

                                         = $1/0.12 - 0.08

                                        = $25

Market price in 3 years = Po(1+g)n

= $25(1+0.08)3

= $25(1.08)3

= $31.49

Explanation:

In this case, we need to calculate growth rate by multiplying the plowback ratio by return on equity. Then, we will calculate the current market price as shown above. Thereafter, we will subject the current market price to a 3-year growth rate to calculate the market price in 3 year's time