Problem:
Alpha Ltd. - 100% Equity Company - is following the payout ratio of 40% throughout the last many years. The financial managers of company are now considering whether they should diminish the payout ratio to 20% (for dividend purpose) and use the remaining 20% for stock repurchase for next year. It would like you to analyze the impact of change in policy on its stock prices after taking into the following facts.
(i) Before tax required rate of return by equity shareholders is 15%
(ii) Current year EPS was Rs. 10 and the company has just paid dividend of Rs. 4 per share.
(iii) Historical growth rate of EPS and dividend were 9%
Required:
Question 1: Evaluate the current market price of stock before initiating such policy change.
Question 2: What will be the impact of above policy change on stock price? Evaluate the expected market price which will prevail after the announcement of policy change.
Question 3: Assume the company has decided not to declare neither any dividend nor any stock repurchase. It retains all profits and re-invests in projects that offer 15% return. What will be impact of such change in dividend policy on stock price if dividends are taxed at 30% and capital gains are taxed at 10%?