Question

 Solarpower Systems expects to earn

​$20

per share this year and intends to pay out

​$10

in dividends to shareholders​ (so,

Upper D 10 (D0=$10​)

and retain

​$10

to invest in new projects with an expected return on equity of

19​%.

In the​ future, Solarpower expects to retain the same dividend payout​ ratio, expects to earn a return of

19​%

on its equity invested in new​ projects, and will not be changing the number of shares of ordinary shares outstanding.

a.  Calculate the future growth rate for​ Solarpower's earnings.

b.  If the​ investor's required rate of return for​ Solarpower's share is

14​%​,

what would be the price of​ Solarpower's ordinary​ shares?

c.  What would happen to the price of​ Solarpower's ordinary shares if it raised its dividends to

​$14

thisyear and then continued with that same dividend payout ratio​ permanently? Should Solarpower make this​ change? ​ (Assume that the​ investor's required rate of return remains at

14​%.)

d.  What would happened to the price of​ Solarpower's ordinary shares if it lowered its dividends to

​$4

and then continued with that same dividend payout ratio​ permanently? Does the constant dividend growth rate model work in this​ case? Why or why​ not? ​ (Assume that the​ investor's required rate of return remains at

14% and that all future new projects will earn

19​%.)

Answer 1

a. Future Growth rate for Solarpower's earnings-

First we need to find Retention Ratio =

=

= 50%

Growth Rate = Retention ratio * Return on capital Employed

= 0.50 * 0.19

= 9.5%

b. Price of ​ Solarpower's ordinary​ shares when Rate of Return is 14%

DPS1 = DPS0 + G = 10 + 9.5% = $10.95

Price =

Where,

Ke = Rate of Required Return

G = Growth Rate

Price =

Price = $243.33

C. Price of​ Solarpower's ordinary shares if it raised its dividends to $14

First we need to find Retention Ratio =

=

= 30%

Growth Rate = Retention ratio * Return on capital Employed

= 0.30 * 0.19

= 5.70%

Price of ​ Solarpower's ordinary​ shares

DPS1 = DPS0 + G = 14 + 5.70% = $14.798

Price =

Price =

Price = $178.289

Thanks if you have any query related to answer then feel free to ask me in a comment.