I figured out Part A but I can\'t figure out part B: A. Surf & Turf Hotels is a
ID: 2453996 • Letter: I
Question
I figured out Part A but I can't figure out part B:
A. Surf & Turf Hotels is a mature business, although it pays no cash dividends. Next year’s earnings are forecasted at $56 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 12%.
Earnings per share / Ke - g = Stock price
(56/10)/(.12-.05)=80.0
Thus, the value of S & T per share price as per DCF model is $80
B. Now Surf & Turf ”s CFO announces a switch from repurchases to a regular cash dividend. Next year’s dividend will be $2.80 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 you expect to happen to Surf & Turf ’s stock price?
Explanation / Answer
Part B
Expected Dividend = 2.80
Growth rate in 100% retention = 5% (given)
Growth rate in 50% retention= 5*50% = 2.5%
Cost of Equity =12%
As per DCF
Stock Price = Expected Dividend/(Cost of Equity-growth rate)
Stock Price = 2.80/(12%-2.5%)
Stock Price = $ 29.47
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