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Constant Growth, Constant Investing

Firm Q has EPS of $10 at the end of the first year and a dividend pay-out ratio of 40%, rE = 16% and a return on investment of 20%. The firm takes advantage of its growth opportunities each year by investing retained earnings.

PV(GO) model

1st investment = 0.6 × $10 = $6, which generates 0.2 × $6 = $1.20

Per share PVGO1 = -6 + (1.20/0.16) = $1.50 (at t=1)

2nd investment = 0.6 × $11.20 = $6.72, generating 0.2 × $6.72 = $1.344

Per share PVGO2 = -6.72 + (1.344/0.16) = $1.68 (at t=2)

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