Randal Flapjack is a retired short-order cook living on a fixed income in the st
ID: 2721406 • Letter: R
Question
Randal Flapjack is a retired short-order cook living on a fixed income in the state of Utopia where all financial markets are perfectly efficient. Randal has 20,000 shares of the Sugarcooky Corp., which pays an annualized dividend of $1 per share. Sugarcooky sells at a P/E of 10, has maintained a payout ratio of 44.5% for many years and has not grown in some time. Management has recently announced that it will reduce Sugarcooky's payout ratio to 25% but expects earnings to grow at 5% from now on.
A. What is Sugarcooky's current price? Round the answer to two decimal places.
B. How much current income is Randal losing as a result of management's action? Round the answer to the nearest whole dollar.
C. If Randal keeps his money in Sugarcooky but needs to maintain his current income, how many shares will he have to sell in the first year? Round the answer to the nearest whole number.
D. What will be the value of his remaining shares at the end of a year if the P/E remains the same? Round the answer to the nearest whole dollar.
Explanation / Answer
Dividend payout ratio = DPS/EPS = $1/EPS = 44.5%
EPS = $1/44.5% =$2.25
A. Current Price of Sugarcooky = EPS x P/E ratio = 2.25 x 10 = $22.5
B. If Payout ratio is reduced to 25%, how much Randol loosing
Decrease =EPS X DECREASING PAYOUT RATIO = 2.25 X (44.5%-25%) = 2.25 X 19.5% =$0.44 PER SHARE
Total loss of income = 20,000 shares x $0.44 per share = $8,800
C.To maintain his current income, he has to sell = $8,800/stock price = 8,800/22.5 = 391shares
D. New EPS = 2.25 x (1+0.05) = 2.25 x 1.05 = $2.36
Price = EPS x P/E ratio = 2.36 x 10 = $23.6
New value = 19,609 x 23.6 = $462,772
Old value = 20,000 x 22.5 = $450,000
Growth = $462,772 - $450,000=$12,772
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