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Consider the common stock of Rondo Enterprises, which earlier today reported earnings per share for the previous 12 months (also known as trailing twelve months, TTM) of $3.87 per share. The stock currently trades at $20.72 per share (which may, or may not be, the fair price of the stock). The firm does not buy back stock, nor does it plan to issue new shares in the future. You also expect that it’s ROE will be constant forever, at a level of 8.6% per year. You also expect the firm to continue with its previous dividend-policy in which 34% of earnings are paid out in the form of cash dividends, each year – forever. Based on the risk of the stock, you’ve estimated the fair discount rate (i.e. the expected return), to be 9.8% per year forever. Using the TTM measure of earnings, determine the P/E ratio for the stock, if it was fairly priced. Provide an answer with at least 4 digits of precision

B) You’re interested in LoRa’s common stock. You view the firm as having two different patterns of cash flows in the future – which you think of as “stage 1” and “stage 2”. In the first stage, which lasts until 8 years from today, you expect the firm to pay no dividends. During this first stage, you expect earnings to grow from their current level at a rate of 8.4% per year. The firm recently announced earnings per share for the prior 12 months of $4.91 per share.

Beginning 8 years from today, you expect the second pattern (stage) of cash flows to begin. During this second stage, the firm is expected to have a constant ROE of 9% per year, and a constant Payout Ratio of 23%. The first dividend will be paid 9 years from today (from annual earnings ending 9 years from today).

Based on the stock’s risk, you’ve estimated that the fair discount rate for the stock is 11.7% per year, when measured as an EAR.

You have been asked to determine the “terminal” P/E ratio(i.e. at the end of the first stage, at t = 8), using the following year’s earnings.

Provide an answer with at least 4 digits of precision.

C) Stock Z pays annual dividends. Its next dividend of $2.56 per share is expected in one year. Dividends are expected to grow at an annual rate of 6% per year forever. The stock is currently trading at $49.89 per year. If you bought the stock and held it forever, what annualized IRR would your earn?

Provide an answer as a percentage, not as a decimal, using at least 4 digits of precision.


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