Share price and investment decisions of Zeus Solutions

Zeus Solutions (ZS), an online advertising company, expects next year's after tax earnings to be $20 per share. Its business is still expanding. It plows back 80% of its earnings. The ROE on its new investments is 15%. Its cost of capital is 12.5%.

(a) What is the share price of Zeus Solutions? What is its PVGO (Present Value of Growth Company)?

(b) Suppose that a new competitor comes in and cuts Zeus Solutions' ROE to 12%. How would this impact the company's investment decisions and its share price? Explain why.

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