Question

P10 (similar to) E Quest Help (Measuring growth) Solarpower Systems eamed 520 per share at the beginning of the year and paid out 58 in dividends to shareholders (so. Do = 58) and retained 512 to invest in new projects with an expected return on equity of 21 percent. In the future, Solarpower expects to retain the same dividend payout ratio, expects to earn a return of 21 percent on its equity invested in new projects, and will not be changing the number of shares of common stock outstanding a. Calculate the future growth rate for Solarpower's earings b. If the investor's required rate of return for Solarpower's stock is 15 percent, what would be the price of Solarpower's common stock? c. What would happen to the price of Solarpower's common stock if it raised its dividends to $13 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 15 percent.) d. What would happened to the price of Solarpower's common stock 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 15 percent and that all future new projects will eam 21 percent) a. What is the future growth rate for Solarpower's earnings? 1% (Round to two decimal places) Enter your answer in the answer box and then click Check Answer

Answer 1

a]	Growth rate = ROE*Retention ratio = 21%*12/20 =	12.60%
b]	Price of the stock using the constant dividend growth formula = D0*(1+g)/(r-g)
	where
	D0 = Last dividend paid
	g = growth rate in dividends
	r = required rate of return
	Substituting values, we have
	Price of the stock = 8*(1+0.126)/(0.150-0.126) =	$          375.33
c]	Growth rate = 21%*7/20 =	7.35%
	Price of the stock = 8*(1+0.0735)/(0.150-0.0735) =	$          112.26
	The change should not be made, as it will reduce
	the price of the stock.
	The reason is that the firm can earn 21% on the
	retained profits, which is more than the required
	return of 15%.
d]	Growth rate = 21%*17/20 =	17.85%
	As g is greater than r, the constant dividend growth
	rate model cannot be used.
	If used, it will give a negative value for the share.
	Stock value = 8*(1+0.1785)/(0.15-0.1785) =	$        -330.81