Answer:
a) required rate of return = 10%
b)Also, if there is no growth then Return on Equity will be equal to the Required rate of return. Hence there won't be any change.
c) a cut in the dividend payout to 25% will have no effect or impact and as such the stock price will remain the same.
A complete elimination of dividend will not affect the stock price as well.
Explanation:
The question is in three parts and will be answered accordingly
a) The Required Rate of Return = (The Dividend Expected for the next year/ Current Price of Stock) + the Growth rate
First, we calculate the Dividend expected per share for the next year
=earnings per share x Dividends pay out ratio
=$2 /$10 = 20%
Secondly, we now calculate the return on equity as follows
= Expected Earnings Per share / Current Selling price
= $2 x (1-50%) = 10%
The third is to calculate the Growth rate =
Return on Equity x (1 - Dividend payout ratio)
= 20% x (1-50%) = 10%
Using this with the formula of required rate of return
= ($1 /$10) +10% = 20%
b) First the assumption is that all earnings were paid as dividend with no reinvestment and in this scenario, the lack of reinvestment will mean no growth. Also, if there is no growth then Return on Equity will be equal to the Required rate of return. Hence there won't be any change.
c) Because the Return on Equity is equal to required rate of return, it means a cut in the dividend payout to 25% will have no effect or impact and as such the stock price will remain the same.
A complete elimination of dividend will not affect the stock price as well.
