Metatrend’s stock will generate earnings of $2 per share this year. The discount
ID: 2736352 • Letter: M
Question
Metatrend’s stock will generate earnings of $2 per share this year. The discount rate for the stock is 10%, and the rate of return on reinvested earnings also is 10%.
Find both the growth rate of dividends and the price of the stock if the company reinvests the following fraction of its earnings in the firm: (i) 0%; (ii) 50%; (iii) 60%. (Leave no cells blank - be certain to enter "0" wherever required. Do not round intermediate calculations.)
Reinvestment of Earnings
Redo part (a) now assuming that the rate of return on reinvested earnings is 15%. What is the present value of growth opportunities (PVGO) for each reinvestment rate? (Leave no cells blank - be certain to enter "0" wherever required. Do not round intermediate calculations. Round your answer to 2 decimal places.)
Reinvestment of Earnings
a.Find both the growth rate of dividends and the price of the stock if the company reinvests the following fraction of its earnings in the firm: (i) 0%; (ii) 50%; (iii) 60%. (Leave no cells blank - be certain to enter "0" wherever required. Do not round intermediate calculations.)
Explanation / Answer
Answer: a.
i) Reinvest 0% of earnings: g= 0 and DIV1= $2
(ii) Reinvest 50%:g= 10%* 0.50 = 5% and DIV1= $2 * (1 – 0.50) = $1
(iii) Reinvest 60%:g= 10% * 0.60 = 6% and DIV1= $2 * (1 – 0.60) = $0.8
Answer:2 (i) Reinvest 0%:
P0=2/0.10-0
=20
PVGO = $0
(ii) Reinvest 50%:g= 15%* 0.50 = 7.5% and DIV1= $2 * (1 – 0.50) = $1
P=$1/(0.10-0.075)=40
PVGO = $40 – $20.00 = $20
(iii) Reinvest 60%:g= 15% * 0.60 = 9% and DIV1= $2 * (1 – 0.60) = $0.8
P=0.8/(0.10-0.09)
=$80
PVGO = $80.00 – $20.00 = $60.00
0% 50% 60% Growth rate of dividend 0% 5% 6% Stock Price 2 1 0.8