Question

6. Brewers’ Company's (BRW) common stock is currently trading for $25.00 per share. The stock is expected to pay a $2.50 dividend at the end of the year and BRW's equity cost of capital rE is 14%. (5pts) All handwritten no financial calculator.

(a)If the dividend payout rate (of 75%) is expected to remain constant, then what is the expected growth rate in BRW's earnings? (12pts)

(b)Suppose that BRW has a new investment opportunity that is expected to yield a return of 12%, should BRW reduce its dividend payout rate to 70% in order to invest in this project? Calculate and explain your reasoning. (3 pts)

(c) Could you have arrived at your answer to (b) without calculations? Explain.  

Answer 1

P = 01/(R-8) g=R-D1/P .14 - 2.5/25 4.00% b) Now the earning must be EPS = 2.5/.75 3.33 With a change in dividend payout to 70% New dividend is 3.33*.7 2.33 So new growth rate = 30%*12% 3.60% Price of stock 22.44 Since the value of stock decreases, so this option is not recommended Without calculations also, one can conclude as the return on project is less than equity cost of 14% So this is not recommended