Answer:
Explanation:
a.)
First, find the growth rate using the ROE and the retention rate;
<em>g = ROE + retention rate</em>
g = 0.20 * 0.30
g = 0.06 or 6%
Next, find price using Dividend discount model (DDM);
<em>Price = Div/ (r-g)</em>
where Div = next year's dividend
r = required return
g = growth rate ,
Div = earnings * (1- plowback rate)
Div = $2* 0.70 = $1.4
Next, plug in the numbers to the formula above;
Price = 1.4/ (0.14 - 0.06)
Price = $17.50
Price earnings ratio; PE = Price/ earnings per share
PE = 17.50/ 2 = 8.75
b.) Present value of growth opportunities (PVGO)
Use PVGO formula to find the answer. It is as follows;
PVGO = Price - (E/r)
whereby, E= earnings per share = $2
r = investors required rate of return = 14%
Price = $17.50
PVGO = 17.50 + (2/0.14)
= 17.50 + 14.2857
= 31.7857
Therefore, Present value of growth opportunities is $31.79
