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An analyst gathered the following data about a company:

•A historical earnings retention rate of 60% that is projected to continue into the future.

•A sustainable return on equity of 10%.

•A beta of 1.0.

•The nominal risk-free rate is 5%.

•The expected market return is 10%.

If next year’s EPS is $2 per share, what value should be estimated for this stock?

Question:

•A historical earnings retention rate of 60% that is projected to continue into the future.

•A sustainable return on equity of 10%.

•A beta of 1.0.

•The nominal risk-free rate is 5%.

•The expected market return is 10%.

If next year’s EPS is $2 per share, what value should be estimated for this stock?

A
$20.00.

explanation

1212dividend payout = 1 - earnings retention rate = 1 - 0.6 = 0.4

g = (retention rate)(ROE) = (0.6)(0.10) = 0.06

price = (E)(P/E) = (2) (10) = 20

Alternatively, dividend will be 40% of 2 earnings or 0.80, and

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