The stock of Nogro Corporation is currently selling for $30 per share. Earnings

Question

The stock of Nogro Corporation is currently selling for $30 per share. Earnings per share in the coming year are expected to be $6. The company has a policy of paying out 50% 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. a. 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.) Rate of return % b. By how much does its value exceed what it would be if all earnings were paid as dividends and nothing were reinvested? PVGO $ c-1. If Nogro were to cut its dividend payout ratio to 25%, what would happen to its stock price? Stock price would be decreased Stock price would be unaffected Stock price would be increased c-2. If Nogro eliminated the dividend, what would happen to its stock price? Stock price would be unaffected Stock price would be increased Stock price would be decreased

Explanation / Answer

1)

As per DDM Model intrinsic value of a stock can be calculated by discounting its dividend

Intrinsic Value of Stock = DPS/k

where k is required rate of return

EPS = $6

DPS = $3

Intrinsic Value = $ 30

Therefore k= 3/30*100 =10%

2)

If all earnings were paid as dividend then DPS = $ 6

Therefore Intrinsic Value of stock = $6/.10 = $ 60

Hence stock price will double if entire earning is paid as dividend

3)

Dividend payout is 25%

DPS = 25% *$6 = $ 1.50

Value of stock = $ 1.50/.10 = $ 15

stock price will decrease by $ 15

4) if nogro eliminated the dividend stock price would decrease

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