ABC Enterprises has just paid its annual dividend of $2.00 a share. It intends to maintain its traditional plowback ratio of 60% forever. ABC can earn an ROE of 20% on its investments. The risk-free rate is 5% and the expected return on the market is 15%. ABC has a beta of 1.10. a) Calculate the intrinsic value of ABC's stock. Assume that the price equals the intrinsic value. b) Calculate the present value of growth opportunities (PVGO) for ABC. c) If ABC announces a decision to decrease the dividend payout ratio (i.e., the DPR), what should happen to its current stock price? Explain. (Answer qualitatively and an explanation is required.)

EBK CONTEMPORARY FINANCIAL MANAGEMENT
14th Edition
ISBN:9781337514835
Author:MOYER
Publisher:MOYER
Chapter12: The Cost Of Capital
Section: Chapter Questions
Problem 22P
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ABC Enterprises has just paid its annual dividend of $2.00 a share. It intends to maintain its traditional plowback ratio of 60% forever. ABC can earn an ROE of 20% on its investments. The risk-free rate is 5% and the expected return on the market is 15%. ABC has a beta of 1.10.

a) Calculate the intrinsic value of ABC's stock. Assume that the price equals the intrinsic value. b) Calculate the present value of growth opportunities (PVGO) for ABC. c) If ABC announces a decision to decrease the dividend payout ratio (i.e., the DPR), what should happen to its current stock price? Explain. (Answer qualitatively and an explanation is required.) d) The managers of ABC suggest that a higher growth in dividends can be achieved by increasing the dividend payout ratio. Do you agree with them? Answer in terms of “AGREE” or “DISAGREE.”

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