Question

Sunnyfax Publishing pays out all its earnings and has a share price of $ 35.00 . In order to​ expand, Sunnyfax Publishing decides to cut its dividend from​ $3.00 to​ $2.00 per share and reinvest the retained funds. Once the funds are​ reinvested, they are expected to grow at a rate of 11 ​%. If the reinvestment does not affect​ Sunnyfax's equity cost of​ capital, what is the expected share price as a consequence of this​ decision?

Answer 1

Answer:

$40.80

Explanation:

In this question , we are asked to calculate the expected share price as a result of some decisions taken.

We proceed as follows;

growth rate = b x r = (1 x 0.11/3) = 3.67%

New Dividend = $2

cost of equity = 3/35= 8.57%

Price of the stock = New Dividend/( cost of equity - growth rate)

= 2/(0.0857 -0.0367)

= $40.80

Answer 2

Answer:

$40.49

Explanation:

currently the required rate of return (since all profits are distributed):

$35 = $3 / RRR

RRR = $3 / $35 =  0.857 or 8.57%

now we must determine the sustainable growth rate = ROE x (1 - payout ratio)

• ROE = 11%
• payout ratio = $2/$3 = 0.67

sustainable growth rate = g = 11% x (1 - 0.67) = 11% x 0.33 = 3.63%

stock price = next dividend / (RRR - g) = $2 / (8.57% - 3.63%) = $2 / 4.94% = $40.49