Elbur has decided not to go with the acquisition (i.e., it is still all-equity firm). Instead, Elbur considers the following growth plan: it will reinvest $20 of of its earnings today, 3/4 of its year 1 earnings, 2/3 of its year 2 earnings, and then will reinvest 50% of its earnings forever. The after-tax return on equity (ROE) is 25% today, 20% next year, 15% in year 2, and 10% for all remaining years. Each investment pays forever.
1 What is Elbur’s price, P 0 , with this reinvestment policy?
2 You have an option to cancel all investments after year 2. Would you take it? Please give a quantitative answer.
