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Suppose that the consensus forecast of security analysts of your favorite company is that earnings next year will be $5.00 per share. The co
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Suppose that the consensus forecast of security analysts of your favorite company is that earnings next year will be $5.00 per share. The company plows back 50% of its earnings and if the Chief Financial Officer (CFO) estimates that the company’s return on equity (ROE) is 16%. Assuming the plowback ratio and the ROE are expected to remain constant forever:
If you believe that the company’s required rate of return is 10%, what is your estimate of the price of the company’s stock?
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Mathematics
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2021-07-31T16:04:31+00:00
2021-07-31T16:04:31+00:00 1 Answers
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Answer:
$250
Step-by-step explanation:
according to the constant dividend growth model
price = d1 / (r – g)
d1 = next dividend to be paid
r = cost of equity
g = growth rate
Sustainable growth rate is the rate of growth a company can afford in the long term
sustainable growth rate = plowback rate x ROE
b = plowback rate. It is the portion of earnings that is not paid out as dividends
g = 0.50 x 0.16 = 0.08 = 8%
5 / (10% – 8%)
5 / 2%
5 / 0.02 = $250