9, (worth a total of 14 points): Sanders, Inc. currently pays out 100% of its ea

Question

9, (worth a total of 14 points): Sanders, Inc. currently pays out 100% of its earnings to shareholders as dividends. It expects to yield $4 earnings per share next year. The CAPM required rate of return for Sanders, Inc is 12%. a) (worth 4 points): Calculate the current intrinsic value of Sanders' stock, if the firm keeps its current payout policy forever. b) (worth 10 points):If management of Sanders, Inc. just discovers a profitable growth opportunity, with ROE=15%. The management decides to pay out only 40% of its earnings starting from the growth opportunity. Suppose the growth opportunity lasts forever, what is the present value of its growth opportunity (PVGO)? next year's dividend and forever after, so that it can reinvest the rest in the

Explanation / Answer

a. Current price of stock = D1/ WACC

= 4/ 125

= $ 33.33

b.

Growth rate = ROE * Retention rate

= 15%* (1-0.4)

= 9%

Next year dividend = $4*115%*40% = 1.84

Price of share= 1.84/ (12%-9%) = $61.33

PVGO = Price with growth - price without growth =

=61.33- 33.33

= $ 28

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