1. Will-O-Wind Airlines always invests (in non-depreciating assets) 20% of its earnings, which will be next period (Period 1) $3 per share. The rest it pays out as dividends. Its investment opportunities currently earn (and are expected to earn in the indefinite future) 18%. There are no taxes. The risk adjusted required rate of return on this stock is 10%. What is its price?
2. The current earnings of Video Inc. are $2.00 a share, and it has just paid an annual dividend of 40 cents. You forecast that for the next four years both earnings and dividends of the company will continue grow at the rate of 25% a year over the period. From year 5 on, you expect the subsequent growth rate to drop to the industry average of 8%. If the capitalization rate for the stock is 15%, calculate its price and the present value of growth opportunities [PVGO].
3. You are an analyst evaluating Up-and-Coming Airlines Inc., a very hot potential acquisition candidate your company is considering. Up-and-Coming currently has no debt and you estimate that it should be able to generate $1 million a year from its existing assets (after tax cash flow). Furthermore, it has the opportunity to invest one-half of its earnings indefinitely. You estimate that because of better management, your company should be able to improve the rate of return that Up-and Coming can earn on its new investment opportunities. The appropriate discount rate for Up-and-Coming's cash flows is 10%. Up-and-Coming can be purchased for $60 million and management asks you what you think. What rate of return would Up-and-Coming have to earn on its new investments to justify such a price?