Question

Gonzo Growth Corporation has never paid a dividend, and will not pay one in the next year. However, in exactly two years, it plans to begin paying a dividend equal to 40% of its earnings at that time (i.e, the earnings at the end of year 2). Gonzo’s earnings are expected to be $12.00 per share in the coming year, and it expects earnings to grow by 20% over the following year until the dividend is paid (i.e., from years 1 to 2). After it begins paying the dividend, Gonzo expects future growth to level off at 5% per year afterwards.  

Based on these assumptions, what dividends will Gonzo pay in the next three years?     

Note that you do not need to find the current stock price – all you have to calculate are the dividends D1, D2 and D3, to the nearest cent. Be sure to give your answer to only two decimal places (i.e. to the nearest cent).

[Also note: You will not get full credit if you get the timing wrong. D1 is the dollar amount that will be paid in dividends per share in year 1. It's not the first positive dividend amount that will ever be paid - it's the amount, whatever it is, that will be paid in that specific year. Timing matters.]

D1=____

D2=____

D3=____

Answer 1

Calcuate D1, D2 and D3

Earning per share(EPS) Year 1 = $12 , Payout ratio = 40% in year 2 ,  20% growth from Year 1 to 2 and After wards 5%

A) D1 = 0

D1 is the dividend at the end of year 1 and it is mentioned that Company is not going to pay dividend in year 1 and will pay 40% in year2. So D1 = 0

B) EPS 1= 12

EPS 2 = 12 x 1.20 = 14.40 [ 20% growth given in year 1 to 2]  

D2 is the dividend i the end of year 2 and it is mentioned that company will pay 40% dividend.

D2 = 14.40 x 0.40 = 5.76

C) 5% growth afterwards fo D2.

D3 = 5.76 x 1.05 = 6.048

So here are all dividends = D1 =0, D2 = 5.76, D3 = 6.048