Question: Green Corp’s current book return on equity is 10%. Next year, Green Corp is expected to pay a £5 dividend. It has been reinvesting 50%

Green Corp’s current book return on equity is 10%. Next year, Green Corp is expected to pay a £5 dividend. It has been reinvesting 50% of earnings each year.

Suppose Green Corp continues on this growth trend. What is the expected long- run rate of return from purchasing the stock at £120? What part of the £120 price is attributable to the present value of growth opportunities? Explain your calculations carefully.

Now the company announces an expansion plan which requires the company to reinvest 90% of its earnings for three years. Starting in year 4, however, it will again be able to pay out 50% of earnings.

What will be Green Corp’s stock price once this announcement is made and its consequences for the company are known? Explain your calculations carefully.

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