Question

Solarpower Systems expects to earn $20 per share this year and intends to pay out $8 in dividends to shareholders and retain $12 to invest in new projects with an expected return on equity of 20 percent. In the future, Solarpower expects to retain the same dividend payout ratio, expects to earn 20 percent return on its equity invested in new projects, and will not be changing the number of shares of common stock outstanding.
a. Calculate the future growth rate for Solarpower’s earnings.
b. If the investor’s required rate of return for Solarpower’s stock is 15 percent, what would be the price of Solarpower’s common stock?
c. What would happen to the price of Solarpower’s common stock if it raised its dividends to $12 this year and then continued with that same dividend payout ratio permanently? Should Solarpower make this change? (Assume that the investor’s required rate of return remains at 15 percent.)
d. What would happen to the price of Solarpower’s common stock if it lowered its dividends to $4 this year and then continued with that same dividend payout ratio permanently? Does the constant dividend growth rate model work in this case? Why or why not? (Assume that the investor’s required rate of return remains at 15 percent and that all future new projects will earn 20 percent.)



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  • CreatedOctober 31, 2014
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