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17 August, 08:19

Ace Ventura, Inc., has expected earnings of $5 per share for next year. The firm's ROE is 15%, and its earnings retention ratio is 40%. If the firm's market capitalization rate is 10%, to the nearest dollar what is the present value of its growth opportunities

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  1. 17 August, 12:19
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    Answer: $25

    Explanation:

    Value with no growth = Expected earnings/Market capitalization rate

    = $5/10%

    = $5/0.1

    = $50

    Growth rate = Earnings retention ratio * ROE

    Growth rate = 40% * 15%

    = 40/100 * 15/100

    = 0.4 * 0.15

    = 0.06 = 6%

    Value with growth = [$5 * (1-0.4) ] / (0.10 - 0.06)

    = ($5 * 0.6) / 0.04

    = $3/0.04

    = $75

    Present value of growth opportunities will now be:

    = Value with growth - value with no growth

    = $75 - $50

    = $25
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