Question

The stock of Nogro Corporation is currently selling for $20 per share. Earnings per share in the coming year are expected to be $3. The company has a policy of paying out 40% of its earnings each year in dividends. The rest is retained and invested in projects that earn a 15% rate of return per year. This situation is expected to continue indefinitely. a. Assuming the current market price of the stock reflects its intrinsic value as computed using the constant-growth DDM, what rate of return do Nogro's investors require? (Do not round intermediate calculations.) Rate of return b. By how much does its value exceed what it would be if all earnings were paid as dividends and nothing were reinvested? PVGO C-1. If Nogro were to cut its dividend payout ratio to 25%, what would happen to its stock price? Stock price would be decreased Stock price would be increased Stock price would be unaffected ООО c-2. If Nogro eliminated the dividend, what would happen to its stock price? Stock price would be increased Stock price would be decreased Stock price would be unaffected ООО

Answer 1

Solution:

A) D1 = E1 * (1 - b),

= $3 * 0.40,

= $1.20,

g = b * ROE,

= (1 - 0.40) * 15%,

= 9%.

k = [D1/P0] + g

= [$1.20/$20] + 0.09,

= 0.06 + 0.09,

= 0.15, or 15%.

B) PVGO = P0 - [E1/k]

= $20 - [$3 / 0.15]

= $20 - $20

= $0,

C. Option C - Stock Price Would be Unaffected is correct answer,

Since k= ROE, the stock price would be unaffected if Nogro were to cut its dividend payout ratio to 15%. The additional earnings that would be reinvested would earn the ROE (15%).

D. Option C - Stock Price Would be Unaffected is correct answer,

Again, if Nogro eliminated the dividend, this would have no impact on Nogro’s stock price since the NPV of the additional investments would be zero.

Please give a Positive Rating..