Please use the following information for questions 5-8. Stock A pays an earnings
ID: 2800863 • Letter: P
Question
Please use the following information for questions 5-8.
Stock A pays an earnings of $5 per share in year 1. The return on equity is 20%. The discount rate is 10%.
5. If there is no plow-back, what is the stock price now (P0) ?
A) $40
B) $50
C) $60
D) $70
E) None of the above
6. If there is a plow-back of 40%, what is the dividend per share at year 1 (Div1)?
A) $5
B) $4
C) $6
D) $3
E) None of the above
If there is a plow-back of 40%, what would be the price for stock A one year from now (P1)?
A) $150
B) $162
C) $172
D) $ 182
E) None of the above
8.If there is a plow-back of 40%, what is the earnings per share at year 2?
A) $5.0
B) $5.4
C) $5.8
D) $6.2
E) None of the above
Explanation / Answer
5)since plowback ratio is zero
Growth which is given by
g=ROE * Plowbackratio =0
hence Price of stock will be
P=E/k-g = 5/0.1-0 =$50
6) if plowback ratio is 40% that means company is reinvesting 40% of its earnings in the company and paying 60% as dividends
hence dividends for Year 1 will be
5*0.6 = $3
7) if plow back is 40%
growth will be g= ROE * 40% =20% * 40%=0.2*0.4=0.08~8%
price of stock in one year will be
P=D(1+g)/k-g where, D=dividends paid
g= growth
k=cost of equity
P=5*(1-0.4)*(1+0.08)/0.1-0.08
=$162
8) if plowback is 40% growth is 8%
hence earnings after 2 years is 5(1+0.08)^2 =$5.832