Question

The stock of Nogro Corporation is currently selling for $20 per share. Earnings per share in the coming year are expected to be $3.00. The company has a policy of paying out 50% of its earnings each year in dividends. The rest is retained and invested in projects that earn an 18% rate of return per year. This situation is expected to continue indefinitely. a. Assuming the current market price of the stock reflects its intrinsic value as computed using the constant-growth DDM, what rate of return do Nogro’s investors require? (Do not round intermediate calculations. Round your answer to 2 decimal places.) b. By how much does its value exceed what it would be if all earnings were paid as dividends and nothing were reinvested? (Do not round intermediate calculations. A negative amount should be indicated by a minus sign. Round your answer to 2 decimal places.)

Answer 1

1.
=3*50%/20+50%*18%=16.50%

2.
We see that the value exceeded is given as=PVGO=20-3*50%/(3*50%/20+50%*18%)=10.9090909090909