Question

Company A has an ROE of 9%, a beta of 1.25, and with a plowback ratio of 2/3. This year's earnings of A were $3 per share, and the annual dividend was just paid. The consensus estimate of the expected market return is 14% in the upcoming year, and the risk-free return is 6%. Suppose your research suggests that A will momentarily announce a decision that it will immediately reduce its plowback ratio to 1/3. The market is still unaware of this decision. Assume your research is correct, which statement is true regarding A's intrinsic value at the announcement of this plowback ratio change? __________
       
The stock's intrinsic value will rise because fewer earnings will be reinvested in poor ROE.
       
The stock's intrinsic value will keep unchanged because its dividend growth rate shall not change.
       
The stock's intrinsic value will drop because the PVGO value shall be smaller.
       
The stock's intrinsic value will rise because its dividend growth rate shall be higher.

Answer 1

Plowback Ratio means the amount of earnings retained in the business for the growth prospects.

in our current problem the company is going to make announcement of reduction of plowback ratio from 2/3 to 1/3 which means the company will have lower amount of retained earnings for growth prospects which will reduce the growth of the company when the growth of the company reduces the dividend amount payable to shareholders' will be reduced and when dividend paid is reduced obviously intrinsic value of share will reduce .

Thus Option C The stock's intrinsic value will drop because the PVGO value shall be smaller.