Question

10- (similar to) Question Help Measuring growth) Solarpower Systems earned $20 per share at the beginning of the year and paid out $9 in dividends to shareholders (S0, Do = $9) and retained $11 to invest in new projects with an expected return on equity of 21 percent. In the future, Solarpower expects to retain the same dividend payout ratio, expects to earn a return of 21 percent on its equity invested in new projects, and will not be changing the number of shares of common stock outstanding. a. Calculate the future growth rate for Solarpower's earings. b. If the investor's required rate of return for Solarpower's stock is 14 percent, what would be the price of Solarpower's common stock? c. What would happen to the price of Solarpower's common stock if it raised its dividends to $14 and then continued with that same dividend payout ratio permanently? Should Solarpower make this change? (Assume that the investor's required rate of return remains at 14 percent.) d. What would happened to the price of Solarpower's common stock if it lowered its dividends to $4 and then continued 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 investor's required rate of return remains at 14 percent and that all future new projects will earn 21 percent.) a. What is the future growth rate for Solarpower's earnings? % (Round to two decimal places.)

Answer 1

Given,

Earnings per share = $ 20

Dividends per share (D₀) = $ 9

Retained earnings per share = $ 11

Return on equity (ROE) = 21% or 0.21

Solution :-

Retention ratio - Retained earnings Earnings per share $1 -0.55 og 55% $70 Future growth rate (g) - Retention ratio & ROE = S5% X 21% = 12.55% of 0.1155 (b) Required date of return(8) = 14% of 0.14 Price of solar power's Common Stock - Dolltg) - og where, Do - g = 8- Current dividend future growth rate Required rate of return

Common Stock Price - of solar power's 9 (1+0.1155) 0.14 -0.1155 9(1.1155) 0.0245 - 10.0395 0.02US – $409.78 (c) Dividends per Share (Do) $14. Retained earnings = $20-$14 Retention ratio - Retained Earnings Earnings per Share $6 – 0.3 or 30% $20 - Growth rate (g) = Retention ratio x ROE - 30% x 21% 6.37 of 0.063

Price of Common Stock - Do (149) 8 - 2 14 (1+0.063) 0.14 - 0.063 14(1.063) 0.077 - 14.882 = $ 193.27 0.077 Solar power should not make this Change as it reduces the price of the common stock and also the growth rate declines. La Dividends (Do) = $4 Retained earnings = $20-$4. = $16

Retention ratio - Retained earnings Earnings per Share $16 – 0.8 of 80% $20 Growth rate 19 )= Retention ratio x ROE = 80% X 27% = 16.80% es 0.168 Price of Common Stock Do (1+g - g 4( + 0.168) 0.14 - 0.168 - 42.168) -0.028 - 4.622 -0.028 – - $ 166.86 As you can see, the price of common Stock is negative which is not possible. Therefore, Constant dividend growth rate model does not work in this case.