Practice Problem 18 Metatrends stock will generate earnings of $6 per share this year.

The discount rate for the stock is 15%, and the rate of return on reinvested earnings also is 15%. a. Find both the growth rate of dividends and the price of the stock if the company reinvests the following fraction of its earnings in the firm: (i) 0%; (ii) 40%; (iii) 60% b. Redo part (a) now assuming that the rate of return on reinvested earnings is 20%. What is the present value of growth opportunities for each reinvestment rate? Earnings Discount rate Rate of return on reinvested earnings Reinvestment: (a) (i) (ii) (iii) Rate of return on reinvestment (b) Solution: a. (i) Reinvest 0% of earnings: Growth Rate Dividend Stock price (P0) (ii) Reinvest 40% of earnings: Growth Rate Dividend Stock price (P0) (iii) Reinvest 60% of earnings: Growth Rate Dividend Stock price (P0) b. (i) Reinvest 0% of earnings: Stock price with 15% rate of return Stock price (P0) PVGO (ii) Reinvest 40% of earnings: Stock price with 15% rate of return Stock price (P0) PVGO (iii) Reinvest 60% of earnings: Stock price with 15% rate of return Stock price (P0) PVGO $ 6.00 15.00% 15.00% 0.00% 40.00% 60.00% 20.00%

= 0% = $ 6.00 = $ 40.00

= 6.00% = $ 3.60 = $ 40.00

= 9.00% = $ 2.40 = $ 40.00

= $ 40.00 = $ 40.00 = $ -

= $ 40.00 = $ 51.43 = $ 11.43

= $ 40.00 = $ 80.00 = $ 40.00

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