ABC Corp. is an all-equity firm and has 50 million outstanding shares. The firm has a net income of $200 million per year, which is expected to continue at this level forever. The required risk adjusted return to the shareholders is 15%. We also assume that the market is efficient and there are no taxes.

 

1. 1) Assume the firm has a dividend policy of 100% payout forever. What is the company's stock price before paying the current dividend? What is the ex-dividend price of the company's stock if the board follows its current policy?
2. 2) Assume the firm decides to cut the payout to 40% for the next year only, and then reverts to 100% payout forever. What is the company's stock price before paying the current dividend? Does the answer differ from that in part a)? Why?
3. 3) In the real world with taxes and market imperfections, what are the pros and cons of a 40% payout ratio per year compared with a 10% payout ratio for a firm?