A firm has one million shares outstanding. After-tax earnings have been constant at $10 per share. The
Question:
A firm has one million shares outstanding. After-tax earnings have been constant at $10 per share. The firm pays out all earnings in dividends at the end of each year. The shareholders’ required rate of return is 15 percent.
a. Calculate the current share price.
b. The firm considers a one-time retaining of all earnings for the current year. It will revert to a zero retention policy from next year. Assume the new investment promises a return of 10 percent, 15 percent, or 16 percent in perpetuity. Calculate the new share price in each separate case.
c. Is it reasonable for the firm to claim that it would always find enough positive NPV opportunities yielding at least 16 percent, and therefore, it will never pay dividends?
Step by Step Answer:
a b If the firm undertakes the project there will be no dividend in the c...View the full answer
Introduction To Corporate Finance
ISBN: 9781118300763
3rd Edition
Authors: Laurence Booth, Sean Cleary
Related Video
NPV stands for \"Net Present Value,\" which is a financial concept used to determine the value of an investment or project. It measures the difference between the present value of cash inflows and the present value of cash outflows over a given period of time, using a specific discount rate. To calculate the NPV of an investment, you need to first estimate the cash inflows and outflows associated with the investment, and then discount them back to their present values using a discount rate. The discount rate represents the cost of capital or the expected rate of return required by investors. The formula for calculating NPV is: NPV = sum of (cash inflows / (1 + discount rate)^t) - sum of (cash outflows / (1 + discount rate)^t) Where: Cash inflows: the expected cash received from the investment Cash outflows: the expected cash paid out for the investment Discount rate: the required rate of return or the cost of capital t: the time period in which the cash flow occurs If the NPV is positive, it means that the investment is expected to generate a return higher than the required rate of return or the cost of capital, and it may be considered a good investment. If the NPV is negative, it means that the investment is not expected to generate a return higher than the required rate of return or the cost of capital, and it may be considered a bad investment.
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