The ABC Company currently has $16,000,000 in physical assets that have always generated a steady stream of earnings for the company. The management of the firm has always paid all of its earnings to shareholders as a dividend. While there is risk in the return on assets, the average return over many years has been steady at 10 percent. The firm has 1,000,000 shares outstanding. The current ex-dividend price of a share of equity is $15.00.
a. What is the required rate of return for this firm implied by the current market price?
The management wants the company to grow. Rather than pay out all of the firm’s earnings as a dividend this year (t = 0), the management wants to plow back 60 percent of the earnings into the business.
b. Assuming that the management will be able to maintain the return on assets it has achieved in the past as the firm grows, what will be the ex-dividend stock price under the new growth policy?
The ABC Company currently has $16,000,000 in physical assets that have always generated a steady stream of earnings for the company. The management of the firm has always paid all of its earnings to shareholders as a dividend. While there is risk in the return on assets, the average return over many years has been steady at 10 percent. The firm has 1,000,000 shares outstanding. The current ex-dividend price of a share of equity is $15.00. The management wants the company to grow. Rather than pay out all of the firm’s earnings as a dividend this year (t = 0), the management wants to plow back 60 percent of the earnings into the business.
Assuming that the management will be able to maintain the return on assets it has achieved in the past as the firm grows.
c. Given your answer in part b, should the management adopt this policy? Why or why not?