Problem:
Earnings per share for 2010 had been 22.8 pence, and Andrew Osborne expects this to increase to 25 pence per share for 2011. He states that this increase in earnings per share is in line with market expectations of the company's performance. The pattern of recent dividends, which are paid each year on 31 December, is as follows:
Year 2010 2009 2008 2007 2006 2005
Dividend per share (pence) 11.4; 11.1; 9.6; 9.6; 9.2; 8.5
Sir Royston Fairchild, the managing director, proposes that 70 per cent of the earnings in 2010 and subsequent years should be retained for investment in new product development. It is expected that, if this proposal is accepted, the dividend growth rate will be 8.75 per cent. Sir Royston Fairchild had remembered reading an article in the Financial Times that dividends are irrelevant to the share price of a company.
Required: Calculate the share price in the following circumstances:
(a) The company decides not to change its current dividend policy.
(b) The company decides to change its dividend policy as proposed by the Managing Director.
Discount rate: WACC=10.28%