Question

ART has come out with a new and improved product. As a result, the firm projects an ROE of 21%, and it will maintain a plowback ratio of 0.40.
Its earnings this year will be $2.0 per share. Investors expect a 13% rate of return on the stock.

What price do you expect ART shares to sell for in 4 years?

Answer 1

Answer:

$36.012

Explanation:

Data provided in the question:

ROE = 21%

Plowback ratio, b = 0.40

Earnings, E1 = $2.0 per share

Required rate of return on the stock, r = 13%

Now,

Growth rate, g = ROE × b

= 21% × 0.40

= 8.4%

D1 = E1 × (1-b)

= $2.0 × ( 1 - 0.40 )

= $1.2

$V0^{Growth}$ = $\frac{D1}{(r - g)}$

= $\frac{\ 1.2}{(0.13 - 0.084)}$

= $26.087

V4 = $\frac{D5}{(r - g)}$

= $\frac{D1\times(1 + g)^4}{(r - g)}$

= V0 × (1 + g)⁴

= $26.087 × (1 + 0.084)⁴

= 36.019 ≈ $36.012