What is the rate of earnings growth during first six years

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Reference no: EM133578776

Consider a company with expected earnings per share next year of $60, whose ROE for the next 6 years is 15%, and retains all earnings for the next 6 years. Suppose that after these 6 years, ROE falls to 5%, and beginning with year 7, the company chooses to pay out all earnings as dividends. The annual discount rate is 8%. Our goal is to value this company.

(a) If the price of one share of this company in year 6 is P6, what is the price today (i.e., express P0 using P6)?

(b) What is the rate of earnings growth during the first six years of the company? Express E6 as a function of earnings next year E1 and ROE = 15%. Calculate E6.

(d) Compute earnings E7, keeping in mind that ROE falls to 5% at the end of year 6.

(e) Calculate D7 using the fact that the company pays out all earnings starting year 7. Given all earnings are paid out, what is the growth rate of dividends from year 7 on?

(f) Calculate P6, the price in period 6, using the Gordon growth formula (recall, you need to use dividends a period ahead in the Gordon model).

(g) Calculate P0, the stock price today.

Reference no: EM133578776

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