Electronic Inc. has 750,000 shares of stock outstanding, total earnings of $6,000,000, a market price per share of $48, and pays a cash dividend of $2.0 per share. Recently the company has developed a new electronic product on computer motherboard which is more efficient. After investigating the possibility of manufacturing this new product, Electronic determined that the costs involved in building a new plant is very high. The management decided that they are unwilling to invest heavily on it; instead, they can sell the design to an outside firm. The sales of this design can earn an after-tax payment of $30 million.

One way to value a share of stock is the dividend growth, or growing perpetuity model. Consider the following: The dividend payout ratio is 1 minus b, where b is the retention or plowback ratio. So the dividend next year will be the earnings next year E1 x (1- retention%). The most commonly used equation to calculate the sustainable growth rate is the return on equity times the retention ratio. Substituting these relationships into the dividend growth model, well be able to calculate the price of a share today. What are the implications of this result in terms of whether the company should pay a dividend or upgrade and expand its manufacturing capability? Explain.