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Question 6 (Part a, b and c) 10 marks

You are the manager of Grow Co (Grow), and you live in a world where financial markets are inefficient. Grow has a net income of $20 million and has 4 million shares outstanding. Grows shares trade at $100 per share. For some reason, the investors in this world expect the earnings growth rate in the most recent year to continue in perpetuity and use that growth rate to determine the appropriate price-to-earnings ratios of firms. Assume that in this world the P/E ratio for a firm can be calculated via the formula 1/(r g), where r is the discount rate of the company and g is the current years growth rate in earnings per share. Assume the discount rate is 15%. Despite what the name may suggest, Grow can no longer grow its earnings organically. Knowing that the market rewards growth with high price-to-earnings ratios, you choose to artificially grow earnings by acquiring other companies. In each of the next two years, you acquire Alpha Co (Alpha) and Beta Co (Beta), respectively. However, Alpha and Beta also cannot grow its earnings organically. Alphas net income is $5 million, and it has 5 million shares outstanding. Alphas shares trade at $10 per share. You acquire Alpha (in year 1) by offering 1 newly issued Grow share for 10 Alpha shares. Betas net income is $5 million, and it has 8 million shares outstanding. Betas shares trade at $5 per share. You acquire Beta (in year 2) by offering 1 newly issued Grow shares for 25 Beta shares.

(a) What is Grows stock price after acquiring Alpha in year 1? Answer based only on the information provided. (Show all your work.) (4 marks)

(b) What is Grows stock price after acquiring Beta in year 2? Answer based only on the information provided. (Show all your work.) (4 marks)

(c) After Grow acquires Alpha and Beta, what is Grows stock price if investors suddenly realize that Grows growth rate is actually 0%? (Show all your work.) (2 marks)

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