Both Firm A and Firm B earn £10 per share every year in perpetuity and have an annual required return on equity of 10%. Firm A pays out all of its earnings to investors. Firm B retains half of the earnings and pays the other half to its investors. 

Suppose that the ROE is 15% for Firm B. The first dividend will be paid one year from today. Calculate the current share price for both Firm A and Firm B. Discuss why the two prices are different.

Suppose that Firm A decides to follow Firm B by retaining half of its earnings and paying out the other half to investors. However, its ROE is 9%. 

Calculate its new share price and compare it to the original share price. Why is it different? 

Answer rating: 100% (QA)

To calculate the current share prices we can use the formula for the present value of perpetuity PV ... View the full answer