Question

MedTech Industries expects earnings of $1 per share next year. Its return on equity (ROE) is 15% and its plowback ratio is 60%. The company's stock price is $40.

A) What is the cost of capital of this company? (Note: Your answer should be a number in percentage form. Do not enter '%'.)

____%

B) How much of the company's stock value is attributable to the present value of its growth opportunities (PVGO)?

$_____

Answer 1

A) Calculation of cost of Capital

Calculation of Dividend Payout ratio

Dividend Payout Ratio = 100% - plowback ratio

= 100% - 60%

= 40%

Expected Dividend ( D1 ) = EPS * Dividend Payout Ratio

= $ 1 * 40%

= $ 0.40

Sustainable Growth Rate ( g ) = (1 - Dividend Payout Ratio) × ROE

= (1 - 0.40 ) * 15%

= 9%

Current Share Price (P0) = $ 40

Cost of Capital =( D1 / P0 ) + g

= (0.40 / 40) +.09

= 0.01 + .09

= 0.10

= 10%

the cost of capital of this company = 10%

B) Calculation of present value of its growth opportunities (PVGO)

PVGO = Stock Price - ( EPS / Cost of Equity)

= $40 - ( $ 1 / 10%)

= $40 - $ 10

= $30

So, present value of its growth opportunities (PVGO) = $ 30