PRIN.OF CORPORATE FINANCE
13th Edition
ISBN: 9781260013900
Author: BREALEY
Publisher: RENT MCG
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Textbook Question
Chapter 16, Problem 29PS
Dividend policy and the
The current price of the shares of Charles River Mining Corporation is $50. Next year’s earnings and dividends per share are $4 and $2, respectively. Investors expect perpetual growth at 8% per year. The expected
We can use the perpetual-growth model to calculate stock price:
Suppose that Charles River Mining announces that it will switch to a 100% payout policy, issuing shares as necessary to finance growth. Use the perpetual-growth model to show that current stock price is unchanged.
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The dividend-growth model,
suggests that an increase in the dividend growth rate will increase the value of a stock. However, an increase in the growth may require an increase in retained earnings and a reduction in the current dividend. Thus, management may be faced with a dilemma: current dividends versus future growth. As of now, investors’ required return is 12 percent. The current dividend is $0.9 a share and is expected to grow annually by 8 percent, so the current market price of the stock is $24.3. Management may make an investment that will increase the firm’s growth rate to 9 percent, but the investment will require an increase in retained earnings, so the firm’s dividend must be cut to $0.4 a share. Should management make the investment and reduce the dividend? Round your answer to the nearest cent.
The value of the stock to $ , so the management make the investment and decrease the dividend.
A company is considering the following two dividend policies for the next five years.
Year
Policy #1
Policy #2
1
$4.00
$6.00
2
$4.00
$2.70
3
$4.00
$5.00
4
$4.00
$3.10
5
$4.00
$3.20
Required:
Part 1: How much total dividends per share will the stockholders receive over the five year period under each policy?
Part 2: If investors see no difference in risk between the two policies, and therefore apply a 9.4% discount rate to both, what is the present value of each dividend stream?
Part 3: Suppose investors see Policy #2 as the riskier of the two. And they therefore apply a 9.4% discount rate to Policy #1 but a 14% discount rate to Policy #2. Under this scenario, what is the present value of each dividend stream?
Part 4: What conclusions can be drawn from this exercise?
An analyst gathers the following information about a company and the market:
Current market price per share of common stock
€38.00
Most recent dividend per share paid on common stock
€2.50
Expected dividend payout rate
30%
Expected return on equity (ROE)
12%
Beta for the common stock
1.5
Expected return on the market portfolio
12%
Risk-free rate of return
4%
Using the dividend discount model approach, the cost of common equity for the company is closest to:
Chapter 16 Solutions
PRIN.OF CORPORATE FINANCE
Ch. 16 - Dividend payments In 2017, Entergy paid a regular...Ch. 16 - Dividend payments Seashore Salt Co. has surplus...Ch. 16 - Repurchases Look again at Problem 2. Assume...Ch. 16 - Repurchases An article on stock repurchase in the...Ch. 16 - Company dividend policy Here are several facts...Ch. 16 - Prob. 7PSCh. 16 - Information content of dividends What is meant by...Ch. 16 - Information content of dividends Does the good...Ch. 16 - Information content of dividends Generous dividend...Ch. 16 - Prob. 11PS
Ch. 16 - Payout policy in perfect capital markets Go back...Ch. 16 - Payout policy in perfect capital markets Go back...Ch. 16 - Payout policy in perfect capital markets Respond...Ch. 16 - Prob. 15PSCh. 16 - Repurchases and the DCF model Hors dAge...Ch. 16 - Repurchases and the DCF model Surf Turf Hotels is...Ch. 16 - Repurchases and the DCF model House of Haddock has...Ch. 16 - Repurchases and the DCF model Little Oil has 1...Ch. 16 - Repurchases and EPS Many companies use stock...Ch. 16 - Dividends and value We stated in Section 16-3 that...Ch. 16 - Payout and valuation Look back one last time at...Ch. 16 - Dividend clienteles Mr. Milquetoast admires Warren...Ch. 16 - Prob. 24PSCh. 16 - Payout and taxes Which of the following U.S....Ch. 16 - Prob. 26PSCh. 16 - Prob. 27PSCh. 16 - Prob. 28PSCh. 16 - Dividend policy and the dividend discount model...Ch. 16 - Prob. 30PS
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- Return on Common Stock You buy a share of The Ludwig Corporation stock for $21.40. You expect it to pay dividends of $1.07, $1.1449, and $1.2250 in Years 1, 2, and 3, respectively, and you expect to sell it at a price of $26.22 at the end of 3 years. Calculate the growth rate in dividends. Calculate the expected dividend yield. Assuming that the calculated growth rate is expected to continue, you can add the dividend yield to the expected growth rate to obtain the expected total rate of return. What is this stock’s expected total rate of return (assume the market is in equilibrium with the required return equal to the expected return)?arrow_forwardAt Litchfield Chemical Corp. (LCC), a director of the company said that the use of dividend discount models by investors is “proof ” that the higher the dividend, the higher the stock price.a. Using a constant-growth dividend discount model as a basis of reference, evaluate the director’s statement.b. Explain how an increase in dividend payout would affect each of the following (holding all other factors constant):i. Sustainable growth rate.ii. Growth in book value.arrow_forwardBased on the Dividend Discount Model, if a company’s projected rate of growth in earnings and dividends is expected to increase, what effect will it have on its stock? Question 9 options: The value would decrease. The value would increase. The value would not change. It is undeterminable.arrow_forward
- The dividend discount model assumes the value of a share of common stock is the present value of all future dividends. One year holding period Assume an investor wants to buy a stock, hold it for one year, and then sell it. The company earned $2.50 a share last year and paid a dividend of $1 a share. The company maintains a 40% payout ratio over time. Financial analysts suggest the firm will earn about $2.75 per share during the coming year and will raise its dividend to $1.10 per share. The risk free rate is 10% and the market risk premium is currently 4%. You project the sale price of this stock a year from now to be $22. ? Estimate the value of this stock. ? Would you buy this stock? Multiple holding period Assume the expected holding period is three years and you estimate the following dividend payments at the end of each year. Year 1 - $1.10 per share The Business School BUACC3701: Financial Management Year 2 - $1.20 per share Year 3 - $1/35 per share The risk free rate is 10% and…arrow_forwardThe Gordon Growth Model or dividend discounting model assumes the following conditions: · The company’s business model is stable; i.e. there are no significant changes in its operations · The company grows at a constant, unchanging rate · The company has stable financial leverage · The company’s free cash flow is paid as dividends Based on the assumptions, fill up the gaps in the following table. You are expected to show detailed calculations where necessary. Stock Current Year dividend Expected growth in dividends Required rate of return Value of a share of stock A RM1.00 3% 5% B 4% 6% RM26.00 C RM1.00 10% RM21.00 D RM0.75 2% RM7.650 E RM1.10 4% 10%…arrow_forwardsuggests that an increase in the dividend growth rate will increase the value of a stock. However, an increase in the growth may require an increase in retained earnings and a reduction in the current dividend. Thus, management may be faced with a dilemma: current dividends versus future growth. As of now, investors’ required return is 9 percent. The current dividend is $1.3 a share and is expected to grow annually by 4 percent, so the current market price of the stock is $27.04. Management may make an investment that will increase the firm’s growth rate to 5 percent, but the investment will require an increase in retained earnings, so the firm’s dividend must be cut to $0.9 a share. Should management make the investment and reduce the dividend? Round your answer to the nearest cent. The value of the stock to $ , so the management make the investment and decrease the dividend.arrow_forward
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