Next year, your company expects net income of $44 million. It pays 50% of its earnings out in dividends and has a cost of equity capital of 11%. Suppose that the company’s re-investment rate (i.e. internal rate of return) on all future retained earnings is 11%.

a. What would be the value of your company if it maintains a dividend payout ratio of 50%?

b. Does the value of the company in a. above change if the payout ratio is reduced to 25%? Why or why not?

c. Find the company's market capitalization one year from now under each of the two dividend policies described in a. and b. Which payout policy leads to a greater increase in stock price?

d. How can you reconcile the seemingly contradictory results obtained in parts b. and c.?

Answer rating: 100% (QA)

a To find the value of the company with a dividend payout ratio of 50 we can use the Gordon growth model which is Value D1 k g WhereD1 expected divide... View the full answer