Question

Surf & Turf Hotels is a mature business, although it pays no cash dividends. Next year’s earnings are forecasted at $70 million. There are 10 million outstanding shares. The company has traditionally paid out 50% of earnings by repurchases and reinvested the remaining earnings. With reinvestment, the company has generated steady growth averaging 5% per year. Assume the cost of equity is 16%.

a. Calculate Surf & Turf ’s current stock price, using the constant-growth DCF model. (Hint: Take the easy route and estimate overall market capitalization.) (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Current stock price

b. Now Surf & Turf's CFO announces a switch from repurchases to a regular cash dividend. Next year’s dividend will be $3.50 per share. The CFO reassures investors that the company will continue to pay out 50% of earnings and reinvest 50%. All future payouts will come as dividends, however. What would be Surf & Turf ’s stock price? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

stock price

Answer 1

Answer :

(a.) Overall Maket Capitalization = [Earnings * Payout Ratio] / [Cost of Equity - Growth rate]

= [70 million * 50%] / [0.16 - 0.05]

= 35 million / 0.11

= 318.181818181 million

Current Market Price = Overall Maket Capitalization / Number of sares outstanding

= 318.181818181 million / 10 million

= 31.82

(b.) Calculation of Expected Dividend Price

Expected Dividend Price = Expected Dividend / (Cost of Equity - Growth rate)

= 3.5 / (0.16 - 0.05)

= 31.82