Question

In: Finance

Solarpower Systems expects to earn $2020 per share this year and intends to pay out $99...

Solarpower Systems expects to earn $2020 per share this year and intends to pay out $99 in dividends to shareholders​ (so,Upper D 0 equals $ 9D0=$9​) and retain $1111 to invest in new projects with an expected return on equity of 1919​%. In the​ future, Solarpower expects to retain the same dividend payout​ ratio, expects to earn a return of 1919​% 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 $13 (d0=13) this year 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 $3 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​%.)

Solutions

Expert Solution

Solution a Earning per share $           20.00
Dividend payment $             9.00
Retention ratio= (Earning - Dividend)/Earning
Retention ratio= (20-9)/20
Retention ratio= 55%
Return available 19%
Growth rate= Retention * Return
Growth rate= 55%*19%
Growth rate= 10.45%
Solution b Current Dividend $             9.00
Rate of return 14.00%
Growth Rate 10.45%
Share Price =Current Dividend*(1+Growth rate)/(Rate of return-Growth Rate)
Share Price =9*(1+0.1045)/(0.14-0.1045)
Share Price $         280.01
Solution c Earning per share $           20.00
Dividend payment $           13.00
Retention ratio= (Earning - Dividend)/Earning
Retention ratio= (20-13)/20
Retention ratio= 35%
Return available 19%
Growth rate= Retention * Return
Growth rate= 35%*19%
Growth rate= 6.65%
Current Dividend $           13.00
Rate of return 14.00%
Growth Rate 6.65%
Share Price =Current Dividend*(1+Growth rate)/(Rate of return-Growth Rate)
Share Price =13*(1+0.0665)/(0.14-0.0665)
Share Price $         188.63
Solution d Earning per share $           20.00
Dividend payment $             3.00
Retention ratio= (Earning - Dividend)/Earning
Retention ratio= (20-3)/20
Retention ratio= 85%
Return available 19%
Growth rate= Retention * Return
Growth rate= 85%*19%
Growth rate= 16.15%
Current Dividend $             3.00
Rate of return 14.00%
Growth Rate 16.15%
Since growth rate here exceeds the required rate of return which will make the denominator
negative so the dividend growth model will not work.

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