The stock of Nogro Corporation is currently selling for $10 per share. Earnings per share in the coming year are expected to be $2. The company has a policy of paying out 50% of its earnings each year in dividends. The rest is retained and invested in projects that earn a 20% rate of return per year. This situation is expected to continue indefinitely.
a. Assuming the current market price of the stock reflects its value, what rate of return do Nogro's investors require?
b. By how much does its value exceed what it would be if all earnings were paid as dividends and nothing were reinvested?
c. What is the PVGO for this company?
d. If Nogro were to cut its dividend payout ratio to 25%, what would happen to its stock price?
e. What did you notice about the relationship between Nogro's dividend payout policy and its price?
f. What do you think is the reason for such relationship?