For the year just ended N company had an earning

For the year just ended, N company had an earnings of$ 2 per share and paid a dividend of $ 1. 2 on its stock. The growth rate in net income and dividend are both expected to be a constant 7 percent per year, indefinitely. N company has a Beta of 0. 8, the risk - free interest rate is 6 percent, and the market risk premium is 8 percent.

P Company is very similar to N company in growth rate, risk and dividend. payout ratio. It had 20 million shares outstanding and an earnings of $ 36 million for the year just ended. The earnings will increase to $ 38. 5 million the next year.

Requirement :

A. Calculate the expected rate of return on N company ’s equity.

B. Calculate N Company ’s current price-earning ratio and prospective price - earning ratio.

C. Using N company ’s current price-earning ratio, value P company ’s stock price.

D. Using N company ’s prospective price - earning ratio, value P company ’s stock price.

A. The expected rate of return on N company’s equity =6% +0. 8*8% =12.4%

B. Current price -earning ratio = (1. 2/2) * (1 +7% )/ (12.4% -7% ) =11. 89

Prospective price - earning ratio = (1. 2/2) / (12. 4% - 70% ) =11. 11

C. P company’s stock = 11. 89* 36/20 = 21. 4

D. P company’s stock = 11. 11* 38. 5/20 = 21. 39