Java Development Company has maintained stable earnings of $7 per share, and has also maintained a 100% payout policy. Recently, Java has decided to start a new line of business to develop luxury housing.
The new line will require Java to change to a policy of retaining 30% of its earnings for the foreseeable future. You estimate that with the new line of business that dividends will grow by 2% per year in perpetuity (after next year). Java’s current cost of capital is 12%.
a. Calculate the intrinsic value of Java Development shares?
b. Calculate Java’s net present value of growth opportunities?