Suppose that the consensus forecast of security analysts of your favorite company is that earnings NEXT YEAR will be E1 = $5 per share. Suppose that the company tends to plow back 50% of its earnings and pay the rest as dividends. If the CFO estimates that the company’s growth will be 8% from now onwards, answer the following questions:
If your estimate of the company’s required rate of return on its stock is 10%, what is the equilibrium price of the stock?
Suppose you observe that the stock is selling for $50 per share and that is the best estimate of its equilibrium price. What would you conclude about either? (1) your estimate of the stock’s required rate of return or (2) the CFO’s estimate of the company future growth rate
Suppose your 10% estimate of the stock’s required rate of return is shared by the rest of the market. What does the market price of $50/share imply about the market’s estimate of the company’s growth rate?