Question

(Measuring growth) Solarpower Systems earned $20 per share at the beginning of the year and paid out $8 in dividends to shareholders (so. Do = $8) and retained $12 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 a return of 19 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 earnings b. If the investor'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's common stock if it raised its dividends to $12 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 13 percent) d. What would happened to the price of Solarpower's common stock if it lowered its dividends to $2 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 al 13 percent and that all future new projects will earn 19 percent) a. What is the future growth rate for Solarpower's earnings? % (Round to two decimal places) Enter your answer in the answer box and then click Check Answer. 5 parts remaining Clear All Check Answer

Answer 1

EPS = 20$

DIV₀= 8$

Retain earning = 12$

ROE = 19%

(a).

growth = (ROE*Retaiontion ratio)

= 19*(0.6)

= 11.4%

(b).

price of stock = [Div₁/(k_e-g)]

Div₁ = Divident of Next Year

K_e= investor's required rate of return

g = Growth Rate

= [8.912/(0.13-.114)]

= 557$

(c)

Now we have to just put value of divident =12*(1.076)= 12.912

Now new growth rate = 19*(40%) = 7.6%

Stock prices = [12.912/(.13-0.076)]

=239.11

Solar power should not make this change because it will reduce stock prices.

(d)

New growth rate = 19(90%) = 17.1%

Divident₁ = 2.342

Here constant divident Growth model will not be useful because here the growth rate is greater than required rate of return. Which results into the infinite value of share so here constant divident Growth model will not useful.