Question

The fi corporation's dividends per share are expected to grow indefinitely by 5% per year.

Answer 1

Answer:

Explanation:

a.)

Dividend discount model(DDM) is used to determine the price of a stock.

The formula is as follows;

Price ;P0 = D1 /(r-g)

D1 = Dividend in year 1

r = capitalization rate or required rate of return

g = dividend growth rate

P0 = 8/( 0.10-0.05)

P0 = 160.

The price of the Fi corporation's stock is therefore $160.

b.)

Use the formula that shows the relationship between ROE , retention rate and growth rate. It's as follows;

g = ROE *b

g = growth rate

b = retention rate

Given Earnings per Share (EPS) = $12  and dividend = $8, find dividend payout ratio first.

retention ratio = (1 -dividend payout ratio)

dividend payout ratio = 8/12 = 0.667 or 66.7%

retention ratio ; b = (1 -0.667)

b = 0.333 or 33.3%

Plug it in the formula;

0.05 = ROE * 0.333

ROE = 0.05/0.333

ROE = 0.15 or 15%

c.)

This question is asking for the Present Value of Growth Opportunity (PVGO)

The formula is as follows;

PVGO = Price - EPS1 /r

Price = $160 (from part a)

Expected earnings per share (EPS) = $12

required rate of return(capitalization rate) ; r = 10% or 0.10 as a decimal

PVGO = 160 - 12/0.10

PVGO = 160 -120

PVGO = $40

Therefore, the  market is paying $40 per share for growth opportunities.