The stock of Nogro Corporation is currently selling for $28 per share. Earnings

Question

The stock of Nogro Corporation is currently selling for $28 per share. Earnings per share in the coming year are expected to be $7. The company has a policy of paying out a fraction of 0.5 of its earnings each year in dividends. The rest is retained and invested in projects that earn a 25% rate of return per year. This situation is expected to continue indefinitely.

Assuming the current market price of the stock reflects its intrinsic value as computed using the constant-growth DDM, what rate of return do Nogro’s investors require? (Do not round intermediate calculations. Enter the answer as a percentage rounded to 2 decimal places.)

By how much does its value exceed what it would be if all earnings were paid as dividends and nothing were reinvested, i.e., what is the PVGO? (Do not round intermediate calculations. Enter the answer as a numerical number rounded to 2 decimal places.)

The stock of Nogro Corporation is currently selling for $28 per share. Earnings per share in the coming year are expected to be $7. The company has a policy of paying out a fraction of 0.5 of its earnings each year in dividends. The rest is retained and invested in projects that earn a 25% rate of return per year. This situation is expected to continue indefinitely.

Explanation / Answer

a)

Required rate of return = Expected Dividend/Current Share Price + Growth rate

Required rate of return = 7*0.5/28 + 25%

Required rate of return = 37.50%

b)

If there is no growth

Price = Earning/Required rate of returm

Price = 7/37.50%

Price = $ 18.67

PVGO = currently selling price - Price if there is no growth

PVGO = 28-18.67

PVGO = $ 9.33

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