Class Notes (1,035,351)

CA (593,572)

UTSC (34,976)

Management (801)

MGFC10H3 (23)

Sultan Ahmed (23)

Lecture 6

Department

ManagementCourse Code

MGFC10H3Professor

Sultan AhmedLecture

6This

**preview**shows half of the first page. to view the full**2 pages of the document.**Given E1 = $5, D1 = $3, b = 0.4, k = 0.15, and g = 0.08. [In this example, we assume the

constant growth model, that means the firm has constant growth opportunities in every

year.]

What is ROE? ROE = g/b = 0.08/0.4 = 0.2

Value of the firm if no growth =

33.33$

15.0

5

.

Value of the firm with growth =

86.42$

08.015.0

3

.

Then NPVGO = $42.86 – $33.33 = $9.52

Or we can calculate NPVGO directly. Let’s look at the time line below:

Period ………

………

1st growth opportunity

………

2nd growth opportunity ………

3rd growth opportunity ………

4th growth opportunity ………

5th growth opportunity ………

-2.720978

0.46656

0.503885

-2.519424

0.4

0.432

-2.3328

0.432

0.46656

0.432

3

-2

0.4

0.4

0.4

-2.16

5

5

5

5

5

0

5

1

4

2

At the end of year 1, the firm reinvests 40% ($2) of its earnings and this investment will

generate a profit of $0.4 ($2*0.2) per year in years 2, 3, 4, …….( Since ROE = 20%).

*D1 = $5 – $2 = $3

Therefore, the total earnings = $5.4 in year 2. As the firm keeps the same payout ratio, it

reinvests $2.16 ($5.4*0.4) in year 2. This second GO will generate earnings of $0.432

($2.16*0.2) per year forever.

*D2 = $5.4 – $2.16 = $3.24 (= $3*1.08)

So the total earnings in year 3 = $5.832, reinvests $2.3328 ($5.832*0.4) and earns

$0.46656 per year forever.

*D3 = $5.832 – $2.3328 = $3.4992 (=$3*1.08*1.08)

You can calculate the same for year 4, year 5, year 6, …….

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