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Chapter 4: Q13-11B (page 436)

Sisters Corp expects to earn $6 per share next year. The firm’s ROE is 15% and its plowback ratio is 60%. If the firm’s market capitalization rate is 10%, what is the present value of its growth opportunities?

Short Answer

Expert verified

Answer

$180

Step by step solution

01

Given information

EPS = 6

ROE = 15%

Plowback ratio = 0.6

k = 10%

g = ROE x b = 0.15 x 0.6

D1= EPS( 1 - b) = $6 (1 - 0.6)

02

Calculation of price

Formula of Price (Constant Dividend Model) = P0= D1/ k - g

= $6 (1 – 0.6) / 0.10 – 0.15 x 0.6

= $2.4 / 0.10 – 0.09

=$240

03

Calculation of present value of growth opportunity

Price = Price with no growth + present value of growth opportunity

Price = E1/ k + PVGO

= $6 / 0.10 + PVGO

PVGO = $240 - $60

= $180

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