The constant growth dividend discount model says the current market price of the stock reflects its...

 

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The constant growth dividend discount model says the current market price of the stock reflects its intrinsic value and is determined by dividends D₁, the market capitalization rate k and the growth rate of dividends g: Po = D₁ (k - g) The current price of the stock is £10 per share, earnings in the coming year are expected to be £2, the policy of the company is to pay out 50% of its earnings each year in dividends and the retained earnings are reinvested inn projects that earn a 20% rate of return each year. (a) What rate of return will the investors in the company require? [10 marks] (b) If the company were to cut its dividend payout ratio to 25%, what would happen to its share price and why? [10 marks] (C) What will happen to the share price if all earnings were paid as dividends and nothing were reinvested and why? [5 marks] The constant growth dividend discount model says the current market price of the stock reflects its intrinsic value and is determined by dividends D₁, the market capitalization rate k and the growth rate of dividends g: Po = D₁ (k - g) The current price of the stock is £10 per share, earnings in the coming year are expected to be £2, the policy of the company is to pay out 50% of its earnings each year in dividends and the retained earnings are reinvested inn projects that earn a 20% rate of return each year. (a) What rate of return will the investors in the company require? [10 marks] (b) If the company were to cut its dividend payout ratio to 25%, what would happen to its share price and why? [10 marks] (C) What will happen to the share price if all earnings were paid as dividends and nothing were reinvested and why? [5 marks]

Answer rating: 100% (QA)

a Earnings next year are expected to be 2 The dividend payout ratio is 50 so dividends next year wil... View the full answer