Doubts

Review Quiz 03 (Stocks and Bonds), Task 5

Review Quiz 03 (Stocks and Bonds), Task 5

by Frederik Paul Glutting -
Number of replies: 1

Hi Julio,

I have a question regarding Task 5 in the Review Quiz: 03 Stocks and Bonds.

In the solution, EPS₄ is calculated using the formula EPS₄ = ROE × BV₃, which makes sense. However, I initially thought I could continue using the growth rate method, like in previous years:

g=(1−payout)×ROE=0.5×0.2=0.1⇒EPS4=EPS3×(1+g)=2.88×1.1=3.17

Why this approach is incorrect in this context?

Thank you for your help!

In reply to Frederik Paul Glutting

Re: Review Quiz 03 (Stocks and Bonds), Task 5

by Julio Crego -
Hi,

The approach is perfectly correct. However, note that in year 3, there are no dividends (everything is reinvested in year 3); therefore, the growth from 3 to 4 is still 20%:

\(EPS_4=1.2\times EPS_3\)

From 4 to 5, the growth follows your formula and it is 10%.

The intuition is that in year 3, we invest, and it needs a year to produce, so we will see the cash flow the following year.