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XYZ Inc. has expected earnings over the next year of $2/share (E1 = 2). The company is expected to maintain an earnings retention rate of 40%, i.e., 60% of earnings are expected to be paid out as dividends every year. The company has a beta of 1.5, the risk-free rate is 4%, and the market risk premium is also 4%.
If the growth rate in earnings is expected to be 5% in perpetuity
i. What is the value of the stock?
ii. What is the expected price a year from now?
iii. What is the expected holding period return over the next year? How much of this return is due to capital gains (price appreciation = P1/P0-1) and how much is attributable to dividend yield (D1/P0)?
iv. What ROE justifies this growth rate?
v. What is the present value of growth opportunities for this stock?
The risk-free rate of interest is 5% and the expected return on the market is 11%. What would the market risk premium be?
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