Determine the current price of shares, Cost Accounting

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2. Blue-Jay Sporting Goods is a start-up company that expects to earn $3.00 per share next year. Since the firm currently retains 100 percent of earnings to finance future growth, no dividends will be paid on the stock during the next three years. Exactly four years from today, the firm expects to pay a dividend of $5.60 per share from earnings of $8.00 per share.

From date four on, Blue-Jay expects to reinvest retained earnings at an ROA of 15 percent. The required rate of return on the company's stock is 12.5 percent. Assuming that Blue-Jay will retain the same fraction of earnings and reinvest at the same ROA from year four on,

a. determine the current price of shares in Blue-Jay and

b. explain whether and why the price earnings ratio for Blue-Jay will increase or decrease over the next four years.


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