Question

Surf & Turf Hotels is a mature business, although it pays no cash dividends. Next year's earnings are forecasted at $82 million. There are 10 million outstanding shares. The company has traditionally paid out 50% of earnings by repurchases and reinvested the remaining earnings. With reinvestment, the company has generated steady growth averaging 5% per year. Assume the cost of equity is 10%. a. Calculate Surf & Turf 's current stock price, using the constant-growth DCF model. (Hint. Take the easy route and estimate overall market capitalization.) (Do not round intermediate calculations. Round your answer to 2 decimal places.) Current stock price b. Now Surf & Turf's CFO announces a switch from repurchases to a regular cash dividend. Next year's dividend will be $4.10 per share. The CFO reassures investors that the company will continue to pay out 50% of earnings and reinvest 50%. All future payouts will come as dividends, however. What would be Surf & Turf 's stock price? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Stock price

Answer 1

a). Market capitalization = [earnings * (1 - retention ratio)] / (r - g)

= [$82 million * (1 - 0.50)] / [0.10 - 0.05]

= $41 million / 0.05 = $820 million

Stock price = market capitalization / number of shares

= $820 million / 10 million = $82

b). P0 = D1 / (r - g)

= $4.1 / (0.10 - 0.05) = $4.1 / 0.05 = $82