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Stormy Weather has no attractive investment opportunities
Stormy Weather has no attractive investment opportunities. Its return on equity equals the discount rate, which is 5%. Its expected earnings this year are $3 per share. Complete the following table. (Leave no cells blank. Enter a zero, wherever necessary. Do not round intermediate calculations. Round growth rate to two decimal places.) Plowback Ratio Growth Rate P/E Ratio a. 0 $ Stock Price 40 X 40 X 40 X b. 0 % 4.00 X % 8.00 X % 0.40 0.80 10 10 X $ c. $ 10 X
Expert Solution
Case A:
Payout Ratio = 1 - Plowback Ratio
Payout Ratio = 1 - 0.00
Payout Ratio = 1.00
Growth Rate = Plowback Ratio * Return on Equity
Growth Rate = 0.00 * 5.00%
Growth Rate = 0.00%
Expected Dividend = Expected Earnings * Payout Ratio
Expected Dividend = $3.00 * 1.00
Expected Dividend = $3.00
Stock Price = Expected Dividend / (Discount Rate - Growth Rate)
Stock Price = $3.00 / (0.05 - 0.00)
Stock Price = $60.00
P/E Ratio = Stock Price / Expected Earnings
P/E Ratio = $60.00 / $3.00
P/E Ratio = 20.00
Case B:
Payout Ratio = 1 - Plowback Ratio
Payout Ratio = 1 - 0.40
Payout Ratio = 0.60
Growth Rate = Plowback Ratio * Return on Equity
Growth Rate = 0.40 * 5.00%
Growth Rate = 2.00%
Expected Dividend = Expected Earnings * Payout Ratio
Expected Dividend = $3.00 * 0.60
Expected Dividend = $1.80
Stock Price = Expected Dividend / (Discount Rate - Growth Rate)
Stock Price = $1.80 / (0.05 - 0.02)
Stock Price = $60.00
P/E Ratio = Stock Price / Expected Earnings
P/E Ratio = $60.00 / $3.00
P/E Ratio = 20.00
Case C:
Payout Ratio = 1 - Plowback Ratio
Payout Ratio = 1 - 0.80
Payout Ratio = 0.20
Growth Rate = Plowback Ratio * Return on Equity
Growth Rate = 0.80 * 5.00%
Growth Rate = 4.00%
Expected Dividend = Expected Earnings * Payout Ratio
Expected Dividend = $3.00 * 0.20
Expected Dividend = $0.60
Stock Price = Expected Dividend / (Discount Rate - Growth Rate)
Stock Price = $0.60 / (0.05 - 0.04)
Stock Price = $60.00
P/E Ratio = Stock Price / Expected Earnings
P/E Ratio = $60.00 / $3.00
P/E Ratio = 20.00
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