You are now valuing the Southwest Bank, a small bank that is growing rapidly. The bank reported earnings per share of $2.00 in the just-completed financial year and paid out dividends per share of $0.20. The book value of equity at the beginning of the year was $14.00. The beta for the stock is 1.10, the risk free rate is 6% and the risk premium is 4%.
a. Assuming that it will maintain its current return on equity and payout ratio for the next 5 years, estimate the expected growth rate in earnings per share.
b. Assuming that the firm will start growing at a constant rate of 5% a year beyond that point in time, estimate the value per share today. (You can assume that the return on equity will drop to 12% in stable growth and that the beta will become 1.)