Reference no: EM132428798

Question 1: Ergon Inc. expects to have £125 million in earnings at the end of the year and earnings are expected to grow at 6% annually.The firm does not pay any dividends, but it intends to use 25% of its earnings for stock repurchases. Ergon's cost of equity is 15% and it has 25 million shares outstanding. Calculate Ergon's stock price.

Question 2: ABC Corporation expects to have earnings per share of £6 next year. Rather than reinvest these earnings and grow, the firm plans to pay out all of its earnings as a dividend. With these expectations, of no growth, ABC's current share price is £60. Suppose ABC could cut its dividend payout rate to 75% next year and use the retained earnings to open new stores. The return on its investment in these stores is expected to be 12%. Assuming its equity cost of capital and the new growth rate remain unchanged, what effect would this new policy have on ABC's stock price?

Question 3: You are the owner of a firm that currently generates revenues of £1 million per year. Next year, revenues will either decrease by 8% with 60% probability or increase by 10% with 40% probability and then stay at that level for as long as you run the business. You own the firm outright. Also, you have annual costs of £700,000. If you decide to shut down the firm the cost is zero. In that case, you can always sell the firm for £600,000. What is the business worth today if the cost of capital is 12%?