The Vinson Corporation has earnings of $920,000 with 300,000 shares outstanding.
ID: 2653568 • Letter: T
Question
The Vinson Corporation has earnings of $920,000 with 300,000 shares outstanding. Its P/E ratio is 14. The firm is holding $400,000 of funds to invest or pay out in dividends. If the funds are retained, the aftertax return on investment will be 10 percent, and this will add to present earnings. The 10 percent is the normal return anticipated for the corporation, and the P/E ratio would remain unchanged. If the funds are paid out in the form of dividends, the P/E ratio will increase by 10 percent because the stockholders in this corporation have a preference for dividends over retained earnings.
Compute the price of the stock under the two plans. (Do not round intermediate calculations and round your answers to 2 decimal places.)
The Vinson Corporation has earnings of $920,000 with 300,000 shares outstanding. Its P/E ratio is 14. The firm is holding $400,000 of funds to invest or pay out in dividends. If the funds are retained, the aftertax return on investment will be 10 percent, and this will add to present earnings. The 10 percent is the normal return anticipated for the corporation, and the P/E ratio would remain unchanged. If the funds are paid out in the form of dividends, the P/E ratio will increase by 10 percent because the stockholders in this corporation have a preference for dividends over retained earnings.
Explanation / Answer
Compute the price of the stock under the two plans. (Do not round intermediate calculations and round your answers to 2 decimal places.)
Retention plan
Earning = 920000 + 10%*400000 = 960000
EPS = 960000/300000 = 3.2
Share Price = EPS*PE ratio
Share Price = 3.2*14
Share Price = $ 44.80
Payout plan
Earning = 920000
EPS = 920000/300000 = 9.2/3
PE Raio = 14 + 10%*14 = 15.4
Share Price = EPS*PE ratio
Share Price = 9.2/3*15.4
Share Price = $ 47.23
Compute the price of the stock under the two plans. (Do not round intermediate calculations and round your answers to 2 decimal places.)
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