Problem: Zeus Solutions (ZS), an online advertising company, expects next year's after tax earnings to be $20 per share. Its business is still expanding. It plows back 80% of its earnings. The ROE on its new investments is 15%. Its cost of capital is 12.5%.
Q1. What is the share price of Zeus Solutions? What is its PVGO (Present Value of Growth Company)?
Q2. Suppose that a new competitor comes in and cuts Zeus Solutions' ROE to 12%. How would this impact the company's investment decisions and its share price? Explain why.