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Case 7.1. Big G Company An analyst is concerned about the effect of errors in his...

Case 7.1. Big G Company

An analyst is concerned about the effect of errors in his estimates of the future dividend payout ratio for the Big G Company. Assume that the current dividend is $1, return on equity is fixed at 10 percent, and the required rate of return is 15 percent. Using a spreadsheet program, complete the following:

A. Calculate the value of a share of stock today for dividend payout ratios ranging between 5 percent and 75 percent in 5 percentage point increments.

B. Graph the relationship between the stock value and the dividend payout ratios.

C. Describe the relationship between the stock value and the payout ratios. Is the percentage change in the stock price for a 5-percentage point change in dividend payout ratio constant?

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1 current dividend 2 return on equity 3 required return 0.15 Stock value Vs Dividend payout ratio dividend payout ploughback 6 ratio % change in stock ratio growth ratestock value value c) As we can see from the graph, there is inverse relationship between stock value and dividend payout ratio, which means, as dividend payout ratio increases, the stock value decreases. And also from the calculations, we can see that the % change in stock value is not constant for a 5 percentage point 0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.4 0.45 0.5 0.55 0.6 0.65 0.7 0.75 0.95 0.9 0.85 0.8 0.75 0.095 0.09 0.085 0.08 0.075 19.91 18.17 16.69 15.43 14.33 13.38 12.53 11.78 8.75% 8.12% 7.57%) 7.10%) -6.69% -6.32% -5.00% 5.71% 5.45% 5.22% 5.00% -4.81% -4.63% -4.47% 10 15.00 12 0.65 0.6 0.55 0.5 0.45 0.4 0.35 0.065 0.06 0.055 0.05 0.045 0.04 0.035 0.03 0.025 increase in dividend out ratio 15 10.50 9.95 9.45 9.00 8.58 8.20 0.00 17 0.1 0.2 0.4 0.5 0.6 0.7 0.8 Dividend Payout Ratio 20 0.25

1 current dividend 2 return on equity 3 required return 4 0.15 6 dividend payout ratio 7 0.05 8 A7+0.05 9 A8+0.05 10 A9+0.05 11 A10+0.05 12 A11+0.05 13 |-A12+0.05 14 EA13+0.05 15 EA14+0.05 16 |:A15+0.05 17-A16+0.05 18 A17+0.05 19 EA18+0.05 20 =A19+0.05 21 A20+0.05 ploughback ratio growth rate of dividends stock value % change in stock value B7 SB$2 B8*$B$2 B9*$B$2 B10*SB$2 B11 SBS2 B12*$B$2 B13 SBS2 B14*$B$2 B15*$B$2 B16*$B$2 B17*SB$2 B18 $B$2 B19*$B$2 B20*$B$2 B21*$B$2 SBS1*(1+C7)/(SBS2 (SB$1*(1+C8))/(SB$3-C8) (D8-D7)/D7 D9-D8)/D8 1-A8 1-A9 1-A10 1-A11 1-A12 1-A13 1-A14 1-A15 1-A16 1-A17 1-A18 1-A19 1-A20 1-A21 (SB$1* (1+C10))/(SB$3-C10) (D10-D9)/D9 (SB$1 (1+C11)/(SB3-C11)D11 SBS1*(1+C12)/(SB$3-C12) D12-D11)/D11 (SB$1*(1+C13)/(SB$3-C13) D13 (SB$1*(1+C14))/(SB$3-C14) -(D14-D13)/D13 (SB$1*(1+C15)/(SB$3-C15) D15-D14)/D14 ー(SBS1(1+C16))/(SBS3-C16) |:016-015)/015 (SBS1*(1+C17)/(SBS3-C17) (D17-D16)/D16 (SBŚ1*(1+C18)/(SBS3-C18) (D18-D17/D17 (SB$1*(1+C19)/(SB$3-C19) D19-D18)/D18 SB$1*(1+C20)/(SB$3-C20) D20-D19)/D19 SB$1*(1+C21)/(SB$3-C21) (D21-D20)/D20

for each dividend payout ratio, ploughback ratio is calculated , which is the % earnings retained

and also growth rate of dividends for each case is calculated ,

after calculating the above 2 variables ,

stock value = (current dividend*(1+g))/(r-g)

where; r = required return = 15%

g = growth rate of dividends

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