XYZ Inc. has expected earnings over next year of $2/share (E1 = 2). Company is expected to maintain the earnings retention rate of 40%, that is, 60% of earnings are expected to be paid out as dividends every year. Company has beta of 2, risk-free rate is 4%, and market risk premium is also 4%.
a. If growth rate in earnings is expected to be 4% in perpetuity
i. Determine value of stock?
ii. Determine expected price a year from now?
iii. Determine expected holding period return over next year? How much of this return is due to capital gains (price appreciation) and how much is attributable to dividend yield?
iv. What ROE justifies the growth rate?
v. Determine present value of growth opportunities for stock?