Question

Can somebody please help me to solve these problems

3. Doolittle Co. is expected to pay a dividend of $2 next year. Doolittle is expected to pay 30% of its earnings as dividends and will have an ROE of 8% until the fourth year. After that, its ROE is expected to decrease to 5% and the dividend payout ratio will increase to 50%. Applying the cost of equity of 10% and the multistage growth model, compute the intrinsic price of Doolittle. 4. Flanders, Inc., has expected earnings of $5 per share for next year. The firm's ROE is 8%, and its earnings retention ratio is 40%. If the firm's required rate of return is 16%, what is the present value of its growth opportunities?

Answer 1

Growth rate = Retention ratio* Return on equity

PT 3 Growth rate for 1st four year =(1-0.3)8 i.e.5.6%

Growth rate after 4 years =(1-0.5)*5 i.e.2.5%

Intrinsic value = Present value of cash flow

Year	Cash flow	Factor	PV
1	2.000	0.909	1.818
2	2.112	0.826	1.745
3	2.230	0.751	1.675
4	2.355	0.683	1.609
4	32.187	0.683	21.984
			28.830

Terminal value at year 4 = Next year dividend/(Cost of equity- Growth rate)

= 2.355*1.025/(0.1-0.025) i.e. 32.187

Intrinsic value = Present value of cash flow i.e. $28.830

Pt 4

Growth rate = Retention ratio* Return on equity

=0.4*8 i.e.3.2%

Dividend next year =5*0.6 i.e.3

Price today= Next year dividend/(Cost of equity- Growth rate)

= 3/(0.16-0.032) i.e.$23.4375

Present value of growth opportuity = Price- Earning/ Cost of equity

= 23.4375 - 5/.16

= -7.8125