SkyTech Ltd. is expected to pay a per-share dividend next year of $30. The market’s consensus...

SkyTech Ltd. is expected to pay a per-share dividend next year of $30. The market’s consensus is that the firm’s dividend growth rate of 2% per year will be maintained in the foreseeable future. SkyTech’s cost of equity is 10% per year.

(a) What is the price of a share of SkyTech?

(b) Suppose SkyTech’s internal view is that it has an expected average yearly dividend growth of 2% because its return on equity is 8% and management retains 25% of earnings. What is the earnings per share of SkyTech next year? What is the present value of growth opportunities per share of SkyTech?

(c) Suppose SkyTech is about to announce that it will increase its retention ratio to 50%, effective immediately. If the market is still unaware of SkyTech’s decision, what will be the new value of the stock after the change in policy? How would you invest to profit from this fact?

(d) If the dividend policy of SkyTech Ltd. has not shown a clear relationship to its earnings growth, what other absolute valuation model can you use to value the company? What cash flows should be used in the valuation?

Expert Solution

a. if the price of dividend per share is $30 and the growth rate is 2% per year and the cost of equity is 10%. Then the price of share will be $382.50. This value has been calculated using the formula of dividend growth model.

b. Earnings per share will be $5. however, from the question value of preferred dividend is not clear. The formula that has been used in this context is EPS = (I - D)/S. Value of stock of SkyTech is $382.50 and earnings per share is $5 and the cost of equity is 10% therefore, current earning is $5/0.10 = 50. Retained earning of the company is 0.24 and the return on equity is .8. Growth opportunity = 0.25 * 0.8 = 0.2 or 20%.

c. Retention rate will result in decline in earnings per share this will not affect the valuation of share. In this case, profit of the stakeholders of the organisation will decline for limited period of time.

d. Dividend discount model can be used this will help in understanding absolute valuation of the stock. Operating free cash flow can be used in this case this also helps in estimating growth rate model of the company.

jeff jeffy answered 2 weeks ago

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