Question 2 Tabula, Inc. operates in a mature industry as a “cash cow” and thus p

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Question 2

Tabula, Inc. operates in a mature industry as a “cash cow” and thus pays out all of its earnings as dividends. But it has recently developed a new technology that could provide good growth potential, allowing the firm to earn an 8% return on retained earnings in future years. The new technology, however, will require investment. To obtain investment cash, Tabula is considering reducing its dividend payout ratio immediately from 100% to 40%. Current (t=0) earnings and dividends are $285,000. Investors are expecting a return of 10% overall return. In light of this, what is Tabula’s NPVGO?

Explanation / Answer

Answer:

g=ROE*(1-Dividend payout ratio)

=10%(1-0.40)

=6%

NPVGO=$285000*(8%-6%)/(10%-8%)

=$5700/0.02=$285000

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