Solarpower Systems earned $20 per share at the beginning of the year and paid ou

Question

Solarpower Systems earned $20 per share at the beginning of the year and paid out $10 in dividends to shareholders (so, D_0 = $10) and retained $10 to invest in new projects with an expected return on equity of 21 percent. In the future, Solarpower expects to retain the same dividend payout ratio, expects to earn a return of 21 percent on its equity invested in new projects, and will not be changing the number of shares of common stock outstanding. Calculate the future growth rate for Solarpower's earnings. If the investor's required rate of return for Solarpower's stock is 14 percent, what would be the price of Solarpower's common stock? 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 14 percent.) What is the future growth rate for Solarpower's earnings? (Round to two decimal places.) If the investor's required rate of return for Solarpower's stock is 14%, what would be the price of Solarpower's common stock? (Round to the nearest cent.) What would happen to the price of Solarpower's common stock if it had raised its dividends to $12 (D_0= $12) and then continued with that same dividend payout ratio permanently' (Round to the nearest cent.) Should Solarpower make this change? (Select from the drop-down menus.) Solarpower raise its dividend because the retention ratio will and the value of the common stock will

Explanation / Answer

a)

Future growth:

= Return on equity×Retention ratio

= 21%×50%

= 10.5%

b)

Stock price = D1÷(r-g)

D1 is next expected dividend

r is required return

g is growth rate

= $10×(1+10.5%)÷(14%-10.5%)

= $315.71

c)

Stock price = D1÷(r-g)

D1 is next expected dividend

r is required return

g is growth rate

= $12×(1+10.5%)÷(14%-10.5%)

= $378.86

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