1. Tattletale News Corp. has been growing at a rate of 20% per year, and you expect this growth rate in earnings and dividends to continue for another 3 years. The last dividend paid was $7. The discount rate is 15% and the steady growth rate after 3 years is 2%.
a. What is the capital gain in stock price from year 0 to year 1?
b. Calculate the expected rate of return.
2. Web Cites Research projects a rate of return of 10% on new projects. Management plans to plow back 20% of all earnings into the firm. Earnings this year will be $3 per share, and investors expect a 5% rate of return on stocks facing the same risks as Web Cites.
a. What is the sustainable growth rate?
b. What is the stock price?
c. What is the present value of growth opportunities (PVGO)?
d. What is the P/E ratio?
e. What would the price and P/E ratio be if the firm paid out all earnings as dividends?
3. StartUp Industries is a new firm that has raised $370 million by selling shares of stock. Management plans to earn a 20% rate of return on equity, which is more than the 12% rate of return available on comparable risk investments. Half of all earnings will be reinvested in the firm.
a. What will be StartUp's ratio of market value to book value?
b. What will be StartUp's ratio of market value to book value if the firm can earn only a rate of return of 9% on its investments?
4. Here are data on two stocks, both of which have discount rates of 12%:
Stock A Stock B
Return on equity 12% 10%
Earnings per share $2.00 $1.70
Dividends per share $1.20 $1.20
(The earnings per share and the dividends per share represent Year 0 values.)
a. What are the dividend payout ratios for each firm?
b. What are the expected dividend growth rates for each firm?
c. What is the proper stock price for each firm?
5. TrendLine Inc. has been growing at a rate of 5% per year and is expected to continue to do so indefinitely. The next dividend is expected to be $5 per share.
a. If the market expects a 10% rate of return on TrendLine, at what price must it be selling?
b. If TrendLine's earnings per share will be $6, what part of TrendLine's value is due to assets in place, and what part to growth opportunities?