7.7

a. The sustainable growth rate is g=return on equity plowback ratio =10% X.40=4%

b. First value the company. At a 60% payout ratio, DIV = $3 as before. Using the constant- growth model, Po= $3 .12-.04 -= $37.50 which is $4.17 per share less than the company's no-growth value of $41.67. In this exam- ple Blue Skies is throwing away $4.17 of potential value by investing in projects with unattractive rates of return.

c. Sure. A raider could take over the company and generate a profit of $4.17 per share just by halting all investments offering less than the 12% rate of return demanded by investors. This assumes the raider could buy the shares for $37.50.