As an analyst, you are in charge of ?nding the price per share of ABC Inc., which is expected to generate $1,500,000 in earnings next year. You expect the earnings next year to be paid out entirely as dividends. Suppose that the company has 100,000 shares outstanding, and its discount rate is 15%.
(a) If your analysis suggests that ABC will generate the same earnings each year in future forever, and will keep paying them all out, how much each share of ABC is worth?
(b) Suppose that an investment opportunity emerges, by which the company can reduce dividend payment by $300,000 only next year and reinvest the proceeds in the project, whose payo? is 20% per year. The company can then keep paying out all earnings each year after the next year. Do you think ABC should take this investment opportunity? Justify your answer by calculating the NPV of the project.
(c) If the company announces that it will take the investment opportunity in part (b), what should be its current share price?
(d) Suppose that the company changes its strategy. Starting next year, it will reinvest 30% of its earnings every year. As in part (b), the future investments will payo? 20% forever, starting a year after the reinvestment is made. What is the NPVGO per share for this ?rm?