Smirnoff Co.\'s current rate of return (ROE) is 14%. It pays out(payout ratio) h

Question

Smirnoff Co.'s current rate of return (ROE) is 14%. It pays out(payout ratio) half of its earnings as dividends. Current book value is $50 per share. Book value per share will grow as Smirnoff reinvests earnings.

Assume ROE and payout ratio stay the same for the next 4 years. After that competition forces ROE down to 11.5% and payout increases to .8. The cost of capital is 11.5%

a. What are Smirnoff's EPS and dividends next year? How will EPS and dividends grow in years 2, 3, 4, 5 and 6 in subsequent years?

b. What is Smirnoff's stock worth per share? How does that value depend on the payout ratio and growth rate after year 4?

Explanation / Answer

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