Your company currently has a book equity per share of $100. Analyst forecasts state that your return on equity (ROEE) will be 18 percent for the next 5 years (up until t=5), and 4 percent (ROEL) thereafter. Assume that the expected return on equity (the discount rate) for your stock is 5.1 percent. Also assume that these numbers are independent of your dividend policy.
a. Your plan is to plow back 90 percent of your earnings (bE=0.90) in the early period (up until t=5) and 20 percent of your earnings (bL=0.20) in the late period (after t=5). Given this dividend policy, what is the price of your stock today? Show all work
b. Suppose you have control over your dividend policy. What early-period and late-period plowback ratios should you choose to maximize the price of your stock today? Hint: Use Solver in Excel to solve for the early-period and late-period plowback ratios. Suppose your price calculation is in cell B16, and your early and late period plowback ratios are in cells B3 and B4. Set “B16” equal to “max” by changing variable cells “B3,B4”. You also have to constrain B3 and B4 so that they are between 0 and 1, inclusive.