ABC Corp. is an all-equity firm and has 50 million outstanding shares. The firm has a net
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ABC Corp. is an all-equity firm and has 50 million outstanding shares. The firm has a net income of $200 million per year, which is expected to continue at this level forever. The required risk adjusted return to the shareholders is 15%. We also assume that the market is efficient and there are no taxes.
- 1) Assume the firm has a dividend policy of 100% payout forever. What is the company's stock price before paying the current dividend? What is the ex-dividend price of the company's stock if the board follows its current policy?
- 2) Assume the firm decides to cut the payout to 40% for the next year only, and then reverts to 100% payout forever. What is the company's stock price before paying the current dividend? Does the answer differ from that in part a)? Why?
- 3) In the real world with taxes and market imperfections, what are the pros and cons of a 40% payout ratio per year compared with a 10% payout ratio for a firm?
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