03rec3_exercise

03rec3_exercise - (c) Suppose MetaTrend decideds to pay out...

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
MIT Sloan School of Management J. Wang 15.407 E52-456 Fall 2003 Recitation Notes 10/2/2002 1. Company XYZ’s year-end dividend will be $1. It will grow at 10% for 10 years and then slows down to 5% per year forever. The cost of capital for XYZ is 15%. What is the price of company XYZ? Answer: We consider the second stage-growth first. So in 10 years, the value of XYZ will be 1 * (1+10%) 1 0 15% - 5% = $25 . 937 So the value today is: 1 15% * [1 - ( 1+10% 1+15% ) 1 0] + 25 . 937 (1+15%) 1 0 = $13 . 589 2. MetaTrend Corps. earns a book rate of return (ROE) of 12%. It reinvests one-half its earnings and pays out the other half as cash dividends. The nominal cost of capital is 12%. (a) Given this ROE and dividend payout ratio, what is the growth rate of MetaTrend’s earnings and dividends? (b) Assume this growth rate is expected to continue in perpetuity. What is the present value of MetaTrend shares? Assume that book value per share is $10.
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Background image of page 2
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: (c) Suppose MetaTrend decideds to pay out all its earnings as cash dividends. There-fore it does not grow. What is the change, if any, in MetaTrends stock price? Why? Answer: (a) We can use the growth formula growth = ROE (1-payout ratio) = 0 . 12 (1-. 5) = 0 . 06 (b) We can apply the formula of DDM with constant growth P MetaTrend = book value ROE payout ratio cost of capital - growth = 10 . 12 . 5 . 12-. 06 = 10 (c) We can apply the formula of DDM with no growth P MetaTrend = book value ROE payout ratio cost of capital = 10 . 12 . 12 = 10 The price is same as that of part a. The reason is that the dividends gave up exactly oset the present value of the increase of future cash ows, ie ROE = cost of capital. 2...
View Full Document

This note was uploaded on 01/19/2011 for the course 15 15.407 taught by Professor Wang during the Fall '03 term at MIT.

Page1 / 2

03rec3_exercise - (c) Suppose MetaTrend decideds to pay out...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online