Question

Firm reinvests 60% of its earnings in projects with ROE of 10%, capitalization rate is 15%. Expected year-end dividend is $2/share, paid out of earnings of $5/share.

Calculate the dividend growth rate.

Calculate the firm’s intrinsic value.

Calculate the firm’s present value of growth per share.

Why is the PVGO is negative?

Is the current dividend policy a good choice? What could be done to increase its stock price?

Answer 1

Growth rate =

g = b*r

Here b is retention ratio which is calculated as 5-2 = 3 = 3/5 = 60%

and r = 10%

therefore growth rate is 60% * 10% = 6%

Intrinsic value of share is P = EPS(1-g)/(ke-g)

= 5(1-0.60)/(10%-4%) = 2/6% = $33.33

Firm PV of growth per share = Value of stock – (earnings / cost of equity)

= 33.33 - (5/10%) = -16.67

The PVGO of firm is negative because here the Company can retain less money if copany can decrease the retention Ratio than the PVGO becomes positive

No this is not a good choice of Current dividend policy If company wants to increase its stock price then he needs to decrease the retention Ratio Which can increase the stock price