Grow-Now currently has a book value of equity of $100/share. The company is expected to have strong investment opportuni
Posted: Sun May 29, 2022 5:50 pm
Grow-Now currently has a book value of equity of $100/share. The company is expected to
have strong investment opportunities in the near-term, and as such will have a ROE of 14% for the
next 3 years. Because earning per share is equal to the product of book value of equity and ROE, this
implies that the earnings per share (EPS) one year from today will be $14. After this 3-year period, the
company’s investment opportunities will decrease, such that the firm will have an ROE of 7% from
this point onwards. The firm has an equity beta of 1.5, risk-free debt, and a D/E ratio of 0.60. The
market risk premium is 5%, the risk-free rate is 3%, and the corporate tax rate is 0%.
5a. Find the current stock price if the company keeps a constant payout policy of 40%.
5b [tougher]. Can the company increase its share price by changing its payout policy for the first 3
years [hint: try changing the payout policy and recomputing the stock price].
5c [tougher]. If the company keeps a payout policy of 40% for the first 3 years, can the company
increase the share price by changing the payout policy after the first 3 years [you can answer this with
a calculation or qualitative argument].
have strong investment opportunities in the near-term, and as such will have a ROE of 14% for the
next 3 years. Because earning per share is equal to the product of book value of equity and ROE, this
implies that the earnings per share (EPS) one year from today will be $14. After this 3-year period, the
company’s investment opportunities will decrease, such that the firm will have an ROE of 7% from
this point onwards. The firm has an equity beta of 1.5, risk-free debt, and a D/E ratio of 0.60. The
market risk premium is 5%, the risk-free rate is 3%, and the corporate tax rate is 0%.
5a. Find the current stock price if the company keeps a constant payout policy of 40%.
5b [tougher]. Can the company increase its share price by changing its payout policy for the first 3
years [hint: try changing the payout policy and recomputing the stock price].
5c [tougher]. If the company keeps a payout policy of 40% for the first 3 years, can the company
increase the share price by changing the payout policy after the first 3 years [you can answer this with
a calculation or qualitative argument].