In order to evaluate the stock of EasyStreet Corporation, an analyst uses the constant growth discounted dividend model. Expected earnings of $16 per share are assumed, as are an earnings retention rate of 60% and expected rate of return on future investments of 17% per year. If the market capitalization rate is 14% per year, what is the implied net present value of future investments? Answer:g = 0.6 X 0.17 = 10.2% Use the constant growth formula to solve for P0:P0 = D1/(k – g) = $6.40/(0.14 – 0.102) = $168.42 Next find P0 with the formula P0 = E1/k: = 16/0.14 = $114.29 The NPV of future investments is the difference between the two values: $168.42 – $114.29 = $54.13. 5. Organic Earth stock is expected to pay a dividend of $2.70 per share a year from now, and its dividends are expected to grow by 7% per year thereafter. If its price is now $30 per share, what must be the market capitalization rate? Answer:Use the constant growth formula to solve for k:P0 = D1/(k – g) 30 = 2.70/(k – 0.07) k = 16% 6. Walch stock currently sells for $27.62 a share, and is expected to pay a dividend of D1 a year from now. If its dividends are expected to grow by 4.5% per year thereafter and the capitalization rate is 15% per year, what is the value of D1? Answer:Use the constant growth formula to solve for D1:P0 = D1/(k – g) D1 = P0(k – g) = $27.62(0.15 – 0.045) = $2.90