It’s early morning on January 1st, 2014 and Mr. Specter is thinking about investing in Alberta Oil Sands Corp. Alberta Oil Sands Corporation reported earnings per share (EPS) of $2 as of December 31, 2013 but paid no dividends. Earnings are expected to grow at 16% per year for the following 4 years. Alberta Oil Sands Corporation will start paying dividends for the first time on December 31, 2017, distributing 40% of its earnings to shareholders (the payout ratio will remain 40% for four more years). Earnings growth will slow down to 7.5% per year for the next 5 years (i.e. from January 1, 2018 through December 31, 2022). Starting on December 31, 2022 Alberta Oil 2 Sands Corporation will begin to pay out 70% of its earnings in dividends and earnings growth will stabilize at 2% per year forever. The required rate of return r on Alberta Oil Sands Corporation stock is 10%.
(a) How much should Mr. Specter pay for a share of Alberta Oil Sands stock given the above earnings and dividend forecast?
(b) Should Mr. Specter convince Alberta Oil Sands directors to change the company’s future dividend policy such that Alberta Oil Sands would pay out 100% of its December 31, 2022 earnings in dividends instead of pursuing their growth strategy and would then maintain this dividend policy forever?