Question

You expect that Bean Enterprises will have earnings per share of $2 for the coming year. Bean plans to retain all of its earnings for the next three years. For the subsequent two years, the firm plans on retaining 50% of its earnings. It will then retain only 25% of its earnings from that point forward. Retained earnings will be invested in projects with an expected return of 20% per year. If Bean's equity cost of capital is 10%, then the price of a share of Bean's stock is closest to ________.

Answer 1

Answer:

$9.77

Explanation:

We need to calculate the Dividend payments first

First 3 years is 0 because company will retain all the earnings.

In fourth and  fifth years

Dividend = $2 x 50% = $1 per share per year

After fifth year

Dividend = $2 x ( 1 - 0.25) = $1.5

Cost of Capital = 10%

Now we need to determine the present value of each dividend payment.

PV  of first 3 years = $0

PV of 4th and 5th year dividend = $1 x (1+10%)^-4 + $1 x (1+10%)^-5 = $0.0.68 + $0.62 = $1.3

PV of dividend after 5th year = ($1.5 / 10%) x (1 + 10%)^-6 =  $8.47

Total Value = Sum of all present value = $1.3 + $8.47 = $9.77