a) Crab and Apple Co expects that next year’s earnings will be eight dollars per share (EPS1 = $8). The company normally pays out 80% of its earnings in dividends to its shareholders and plans to continue that practice. The company’s financial staff expects that reinvested funds used in its capital spending program can earn a return on equity of 25%. Given the company’s level of risk, shareholders demand a 20% required rate of return. Please help Mr. Gordon to determine the stock price.
b) News Flash. The company just announced that it is changing its dividend policy and the payout ratio next year will be 30%. What happens to the stock price?