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  3. suppose a company has a book value of equity of $2

Suppose a company has a book value of equity of $25 million, and has 1...

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Finance

Suppose a company has a book value of equity of $25 million, and has 1 million shares outstanding. The company is expected to earn a net income of $5 million next year, and plans to plow back 20% of its earnings indefinitely to grow. The company has no debt and the firms equity holders require a return of 10% on their investment. With this information, answer the following three questions. (i) If we assume the company will grow at a constant rate forever, what is the value per share? (ii) Is the intrinsic value per share smaller or larger than the book value, and why? And at what P/E- ratio would the company trade in the market today if the stock is priced correctly? (iii) Now assume that the company will pay a lower dividend of $2 per share next year, and grow this dividend at 12% for 2 years. After this period, the company will pay a dividend of $5.22, which will then grow at a rate of 4% indefinitely. How would this policy affect the value per share?

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