Question

ART has come out with a new and improved product. As a result, the firm projects an ROE of 21%, and it will maintain a plowback ratio of 0.40.

Its earnings this year will be $2.0 per share. Investors expect a 13% rate of return on the stock.

What price do you expect ART shares to sell for in 4 years?

Answer 1

$36.012

Step-by-step explanation:

Data provided in the question:

ROE = 21%

Plowback ratio, b = 0.40

Earnings, E1 = $2.0 per share

Required rate of return on the stock, r = 13%

Now,

Growth rate, g = ROE × b

= 21% × 0.40

= 8.4%

D1 = E1 × (1-b)

= $2.0 × ( 1 - 0.40 )

= $1.2

`V0^(Growth)` =
`(D1)/((r - g))`

=
`(\$1.2)/((0.13 - 0.084))`

= $26.087

V4 =
`(D5)/((r - g))`

=
`(D1*(1 + g)^4)/((r - g))`

= V0 × (1 + g)⁴

= $26.087 × (1 + 0.084)⁴

= 36.019 ≈ $36.012