In the past, Sunnyfax Publishing paid out all its earnings as dividends. When th

Question

In the past, Sunnyfax Publishing paid out all its earnings as dividends. When the stock market opened for trading today, Sunnyfax's share price was $38 and earnings for the year ending today are $3 per share. At the end of the day and after paying their $3 dividend, Sunnyfax surprises investors by announcing they will cut its dividend payout in future years from 100% to 66.67% and reinvest the retained funds. The rate of return on invested capital is expected to be 12%. If the reinvestment does not affect Sunnyfax's equity cost of capital, what is the expected share price as a consequence of this decision? A. $26.34 B. $51.35 C. $53.40 D. $80.11

Explanation / Answer

The expected share price as a consequence of the decision to cut dividend will be $ 51.35, since the dividend payout has reduced, but consequently, we are also getting returns on the capital invested.

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