Chapter 13, Problem 22PS

The stock of Negro Corporation is currently sailing for $\$\text{1}0$ per share. Earnings per share in the coming year are expected to be $\$\text{2}$ . The company has a policy of paying out $\text{5}0\%$ of its earnings each year in dividends. The rest is retained and invested in projects that earn a $\text{2}0\%$ rate of return per year. This situation is expected to continue indefinitely. $\left(\text{LO 13}-\text{3}\right)$
a. Assuming the current market price of the stock reflects its intrinsic value as computed using the constant-growth DDM, what rate of return do Nogro’s investors require?
b. By how much does its value exceed what it would be if all earnings were paid as dividends and nothing was reinvested?
c. If Nogro were to cut its dividend payout ratio to $\text{25}\%$ , what would happen to its stock price?
d. What if Nogro eliminated the dividend?