Firms A & B are identical in all respects. Neither firm has any debt. Both firms have invested capital of $90,000 and 4,000 outstanding shares. Their current book value and market value per share is $22.50. Both firms have a WACC and ROIC equal to 17%. You have purchased 10 shares of Firm A and 10 shares of Firm B.
Firm A pays out 100% of their earnings in the form of dividends.
Firm B pays out 30% of their earnings in the form of dividends.
1) What will be each firm’s share price at the end of year 3?
2) You sell your shares to Elliot at the end of year 3. What will be your realized rate of return for your investment in Firm A and Firm B.
3) Now assume at the end of year 3 expectations have changed and the expected ROIC for both firms have increased to 19% for year 4 and forward. Redo question 2.
4) Based upon your answer to question 3, Elliot sells his shares to Casey at the end of year 6. What will be Elliot’s realized rate of return for his investment in Firm A and Firm B.