The stock of Nogro Corporation is currently selling for $22 per share. Earnings

Question

The stock of Nogro Corporation is currently selling for $22 per share. Earnings per share in the coming year are expected to be $3.20. The company has a policy of paying out 60% of its earnings each year in dividends. The rest is retained and invested in projects that earn a 20% 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. Round your answer to 2 decimal places. Omit the "%" sign in your response.)

By how much does its value exceed what it would be if all earnings were paid as dividends and nothing were reinvested? (Do not round intermediate calculations. Negative amount should be indicated by a minus sign. Round your answer to 2 decimal places. Omit the "$" sign in your response.)

The stock of Nogro Corporation is currently selling for $22 per share. Earnings per share in the coming year are expected to be $3.20. The company has a policy of paying out 60% of its earnings each year in dividends. The rest is retained and invested in projects that earn a 20% 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. Round your answer to 2 decimal places. Omit the "%" sign in your response.)

By how much does its value exceed what it would be if all earnings were paid as dividends and nothing were reinvested? (Do not round intermediate calculations. Negative amount should be indicated by a minus sign. Round your answer to 2 decimal places. Omit the "$" sign in your response.)

Explanation / Answer

The rate of return required by equity investors = D1/P0 + g

Here D1= 3.2*60%=$1.92

P0 = $22

Now g is growth rate which is not given directly

Now if we assume ROE=20%

g= ROE*(1-dividend payout%)= 20%*(1-60%)= 8%

Substituting in above formula we get

Cost of equity Ke =1.92/22 + 8%

The rate of return required by equity investors=Ke =16.73%

b.

If all earnings were paid as dividends

Ke =3.2/22 +8%

Ke =22.54%

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