Question

Bill's Bakery expects earnings per share of $2.34 next year. Current book value is $4.10 per share. The appropriate discount rate for Bill's Bakery is 15 percent. Calculate the share price for Bill's Bakery if earnings grow at 2.70 percent forever. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

Using the Gordon Growth Model, the price per share for Bill's Bakery is calculated to be $19.02 after plugging in the expected earnings, the constant growth rate, and the discount rate.

Step-by-step explanation:

To calculate the share price for Bill's Bakery when earnings grow at a constant rate forever, we can use the Gordon Growth Model (also known as the Dividend Discount Model for perpetual growth). This model requires the next year's expected earnings ($2.34 per share), the constant growth rate of earnings (2.70%), and the discount rate (15%). The formula for the Gordon Growth Model is:

Price per share = Expected Earnings per Share / (Discount Rate - Growth Rate)

Plugging in the numbers for Bill's Bakery:

Price per share = $2.34 / (0.15 - 0.027) = $2.34 / 0.123

Price per share = $19.02 when rounded to two decimal places.

Remember, this model assumes that earnings will continue to grow at a constant rate indefinitely, which is a simplification and may not reflect real-world complexities. Also, it is assumed that all earnings are distributed to shareholders as dividends.