Reference no: EM132774920

Question - Rump Industries Ltd expects its new product will give it a significant first mover advantage in the market and that is expected to provide growth in earnings per share of 400% within the coming year, and 75% growth in each of the subsequent 3 years. After that time, it is expected competitors will have developed and brought to market similar products with the result that Rump would expect earnings growth to drop back to its normal level of 3% per year forever. Rump's cash dividend was 10 cents per share last year and is expected to remain at that amount for each of the next 5 years as the company builds it's retained earnings to finance research and development. In the sixth year, it is expected shareholders will be rewarded with a payout ratio that will be 80% of the earnings per share, and the payout ratio is expected to remain at that level forever. The required rate of return on Rump's ordinary shares is 20% per year and the latest earnings per share was 25 cents.

Required -

(a) Calculate the price that Rump Industries Ltd ordinary shares should be selling for in the market, assuming Rump's growth projections are accurate.

(b) Rodomontade is concerned that Rump's earnings growth projections, as a result of the new product, might be too optimistic in the first four years. Rodomontade is in favour of a more conservative approach and recommends the growth rates should be half (i.e. reduced by 50%) of Rump's projections before growth returns to its normal 3% level. Calculate the price that Rump Industries Ltd ordinary shares should be selling for in the market, using Rodomontade's growth projections.