Aug 20, 2017

What is the stock price and what is the price-earnings (P/E) ratio?

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Penny Central Electricity has existing assets that generate $4 in earnings per share. If the firm does not invest except to maintain existing assets, EPS is expected to remain constant at $4 a year. However, Penny Central can start next year with investing $1 per share a year in developing a newly discovered source for electricity generation. Each investment is expected to generate a permanent 25% return. However, the source will be fully developed by the fifth year of investing in it, which means that no more new investments are possible from year 6 onwards. Investors require an 18% rate of return. a. What is the stock price and what is the price-earnings (P/E) ratio? b. What is the new stock price if the firm could continue to invest exactly $1 per year forever? c. Recalculate the NPVGO if the firm would have had the same investment opportunity for 5 years, but now while maintaining a 75% dividend payout ratio. d. Recalculate the NPVGO if the firm has the investment opportunity in perpetuity maintaining a 25% retention ratio. e. Recalculate the NPVGO if the firm has the investment opportunity in perpetuity maintaining a 25% dividend payout ratio.


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