The stock of Nogro Corporation is currently selling for $10 per share E per shar
ID: 2802800 • Letter: T
Question
The stock of Nogro Corporation is currently selling for $10 per share E per share in the coming year are expected lobeS3 The company has a policy ofpaying out 50%ofits n projects tat earn a 30 % rate ot return per year This situaton is expected to contnue idetntely amigs each year in didends The rest a. Assuming the current market price of the stock refects its intrinsic value as computed using the constant-growth DOM, what rate of return do Nogno's investors require? (Do not round intermediate calculations,j Rate of return b. By how much does its value exceed what it would be if all eamings were paid as divldends and nothing wene relenvester? PVGO S O Stock price would be increased Stock price would be unalected OStock price would be decreased Stock price would be increased Stock price would be unaffected Stock price wouis be decreased Type here to searchExplanation / Answer
A. As per constant growth DDM model,
Price of stock = Expected Dividend/ (rate of return - growth rate)
(Rate of return - growth rate) = Expected dividend/Price of stock
Rate of return = Expected dividend / Price of stock + Growth rate
In this equation, Expected dividend = 50% of expected earnings = $1.5
Price of stock - $10
Growth rate = 30%
So rate of return = 1.5/10 + 0.3 = 45%
b. PVGO is determined as, value of stock minus earnings divided by cost of equity
Hence, PVGO = $10 - $3/0.45
PVGO = $3.33
c. If Nogro cuts its dividend payout ratio to 25%, the stock price would go up, as its retained earnings would be invested to generate more future earnings. Also, this value would be added into its existing stock price. Whenever, a dividend is announced, the stock price is reduced by the dividend amount. Hence if dividend payout goes down the stock price would go up.
d. Stock price would increase if dividends are eliminated for reasons explained in c.
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