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ART has come out with a new and improved product
ART has come out with a new and improved product. As a result, the firm projects an ROE of 27%, and it will maintain a plowback ratio of 0.30. Its earnings this year will be $4.0 per share. Investors expect a 16% rate of return on the stock. What price do you expect ART shares to sell for in 4 years?
a) $44.77
b) $83.15
c) $48.40
d) $52.40
Expert Solution
Growth Rate (g)
Growth Rate = ROE x Plowback Ratio
= 27.00% x 0.30
= 8.10%
Required Rate of Return (Ke) = 16.00% (Given)
Dividend per share (D1)
Dividend per share (D1) = Earnings x (1 – Plowback ratio)
= $4.00 x (1 – 0.30)
= $4.00 x 0.70
= $2.80 per share
Dividend for the 5th Year (D5)
D5 = D1 x (1 + g)^4
D5 = $2.80 x (1 + 0.0810)^4
D5 = $2.80 x 1.365534811
D5 = $3.8235 per share
Expected Selling price in 4 Years (P4)
Expected Selling price in 4 Years = D5 / (Ke – g)
= $3.8235 / (0.16 – 0.0810)
= $3.8235 / 0.0790
= $48.40 per share
Hence, the expected selling price of ART in year 4 will be (c)- $48.40
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