ABC Enterprises has just paid its annual dividend of $2.00 a share. It intends to maintain its traditional plowback ratio of 60% forever. ABC can earn an ROE of 20% on its investments. The risk-free rate is 5% and the expected return on the market is 15%. ABC has a beta of 1.10. a) Calculate the intrinsic value of ABC's stock. Assume that the price equals the intrinsic value. b) Calculate the present value of growth opportunities (PVGO) for ABC. c) If ABC announces a decision to decrease the dividend payout ratio (i.e., the DPR), what should happen to its current stock price? Explain. (Answer qualitatively and an explanation is required.)
Dividend Valuation
Dividend refers to a reward or cash that a company gives to its shareholders out of the profits. Dividends can be issued in various forms such as cash payment, stocks, or in any other form as per the company norms. It is usually a part of the profit that the company shares with its shareholders.
Dividend Discount Model
Dividend payments are generally paid to investors or shareholders of a company when the company earns profit for the year, thus representing growth. The dividend discount model is an important method used to forecast the price of a company’s stock. It is based on the computation methodology that the present value of all its future dividends is equivalent to the value of the company.
Capital Gains Yield
It may be referred to as the earnings generated on an investment over a particular period of time. It is generally expressed as a percentage and includes some dividends or interest earned by holding a particular security. Cases, where it is higher normally, indicate the higher income and lower risk. It is mostly computed on an annual basis and is different from the total return on investment. In case it becomes too high, indicates that either the stock prices are going down or the company is paying higher dividends.
Stock Valuation
In simple words, stock valuation is a tool to calculate the current price, or value, of a company. It is used to not only calculate the value of the company but help an investor decide if they want to buy, sell or hold a company's stocks.
ABC Enterprises has just paid its annual dividend of $2.00 a share. It intends to maintain its traditional plowback ratio of 60% forever. ABC can earn an
a) Calculate the intrinsic value of ABC's stock. Assume that the price equals the intrinsic value. b) Calculate the present value of growth opportunities (PVGO) for ABC. c) If ABC announces a decision to decrease the dividend payout ratio (i.e., the DPR), what should happen to its current stock price? Explain. (Answer qualitatively and an explanation is required.) d) The managers of ABC suggest that a higher growth in dividends can be achieved by increasing the dividend payout ratio. Do you agree with them? Answer in terms of “AGREE” or “DISAGREE.”
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