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%.)

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.

jeff jeffy answered 2 years ago

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