Question

Solar power Systems earned $20 per share at the beginning of the year and paid out $10 in dividends to shareholders (so, D0=$10) and retained $10 to invest in new projects with an expected return on equity of 19 percent. In the future, Solarpower expects to retain the same dividend payout ratio, expects to earn return of 19 percent on its equity invested in its new projects, and will not be changing the number of shares of common stock outstanding. A. Calculate the future growth rate for Solarpower's earnings. b. If the investors's required rate of return for Solarpower's stock is 13 percent, what would be the price of Solarpower's common stock? c. What would happen to the price of Solarpower common stock if it raised its dividends to $13 and then continued with that same dividend payout ratio permently? Should solarpower make this change? (Assume that the investors required rate of return remains at 13 percent) d. What would happened to the price of solarpowers common stock if it lowered its dividends to $4 and the continue with that same dividend payout ratio permanently? Does the constant dividend growth rate model work in this case? Why or Why not? (Assume that the investors required rate of return remains at 13 percent and that all future new projects will earn 19 percent) a. What is the future growth rate for Solarpower's earnings?.

Answer 1

Given,

Earnings per share = $ 20

Dividend (D₀) = $ 10

Retained earnings = $ 10

Return on equity = $ 19%

Solution :-

Retention eaanings Eaanings per Share Retention ratio $10 $20 S0% Novs Future gaoutn rate 19) Retention ratio x Retuan on equity 9.5% or O.095 19% 13% or Required ate of retuan l O.13 Now Price of Solar powerls (ommon Stock Do +2 100040095 0. 13-0.09s $10(1.095 O.035 10.95 O.035 s $312.86

Dividend (Do)$13 - Retainedl Earnings Earnings- Dividenrd 4R0-$13=4 11 Retauned Earnings Eaanings per Shore Retention raho 35% $R0 Growth rate lRetention xatio x Retirn on equity 35% X 19:% 6.65% 0r 0,0665 n- Nows Pnce ot Salar Power's Common Stock Do (1+7 $131+0.0665) O.13-0.0665S (/)

13.0665) O.0635 $13.86 4S 0. 0635 + २)४.34 No, Solar Power Should not hmake tnis change, because it results n ilower grouwtn octe and Jower Stock Prce. d) Dividind Da) $4 Retalned Parnings Earnings- Dividend =4.30-4.4.$16 Retauned earnings Earnings per Share Retenton ratio 16 70 arouth rate l) Reterhion ato Retuan on equity

20%. x19 215.3% or 0.152 Nok Price of Solar Power's (ommon eguity Do +9) $410+0.153) 0.13-0.152 40.152) -0.033 4.608 -0.023 $309.s In this Case, Price of (ommon Stock is n hegatve torm, whichs practically nat possible There dore, (onstant dividendl growth medel would not oork rate