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Have attached the question and draft answer. Need help confirming the accuracy. Please include explanantions. Worth 20 points so should be sure that the answer
Have attached the question and draft answer. Need help confirming the accuracy. Please include explanantions. Worth 20 points so should be sure that the answer is correct.
Problem Set 6 FIN 7000 Kodak used to primarily produce and distribute photographic paper and developing materials for traditional (i.e., non digital) photographic methods. A sizable portion of their business was home photography. Since they were one of the few suppliers of such materials, as the population grew, so did the demand for their product. Consider the value of Kodak in 1970. At that time, the investment capital per share (ICPS) for Kodak was $20. Given their market power, their return on investment was 15%. During that time, the required rate of return on Kodak was .14. In 1970, the policy of Kodak was to plowback 25 percent of its earnings per share. 1. (4pts) For simplicity, assume that Kodak pays a dividend once a year. The next dividend payment will be exactly one year from now. Given Kodak's plowback policy, what was the dividend paid in 1971? Assume that it took all of 1970 to generate the earnings off of Kodak's $20.00 ICPS and that the reinvesting and paying of dividends occurred right at the beginning of 1971. 2. (4pts) Given Kodak's plowback policy, what was the growth rate in the dividends payments through time? 3. (2pts) Given Kodak's plowback policy, the market believed that Kodak could continue to generate 15 percent return on investment and would maintain its payout policy. Given these beliefs, what was a fair price for Kodak in 1970 immediately after it paid its 1970 dividend? 4. (4pts) Given the assumptions listed above, what is the present value of Kodak's growth opportunities? 5. (2pts) If Kodak increased its plowback ratio in 1970, what would have happened to their stock price? Circle one. go up go down no change cannot tell without more information Explain your answer. 6. (4pts) Now consider what has happened to Kodak around the arrival of the new millennium. The biggest development has been digital photography, which does not require the types of chemical processes that was the core of Kodak's business. In fact, Kodak had not been involved with digital photography at all. With the initial discovery and penetration of digital technology, the value of Kodak's stock plummeted. Explain why this happens in terms of the discounted cash flows, payout policy and the present value of growth opportunities. 1 N0 1 ROI = 15% Plowback Ratio = 25% Growth rate = 15%*25% = 3.75% Required Rate of Return = 14% ICPS = $ 20 1. For simplicity, assume that Kodak pays a dividend once a year. The next dividend payment will be exactly one year from now. Given Kodak's plowback policy, what was the dividend paid in 1971? Assume that it took all of 1970 to generate the earnings off of Kodak's $20.00 ICPS and that the reinvesting and paying of dividends occurred right at the beginning of 1971. ICPS = Expected Dividend/(Required return growth rate) Expected Dividend = ICPS*(Required return growth rate) Expected Dividend = 20*(14%3.75%) Expected Dividend = $ 2.05 Answer Dividend paid in 1971 = 2.05 No 2. Given Kodaks plowback policy, what was the growth rate in the dividends payments through time? ROI or ROE = 15% Plowback/Retention Ratio = 25% Growth rate = ROE*Retention ratio Growth rate = 15%*25% Growth rate = 3.75% Answer Growth rate = 3.75% No 3 Answer; Calculation of fair price for Kodak in 1970 immediately after it paid its 1970 dividend: Dividend for the year 1970 = Share price *ROI* (1 Plowback ratio) = $20*15 %*( 10.25) = $2.25 per Share Expected Growth rate (g) = ROI * Plowback ratio = 15%*0.25 = 3.75% = 0.0375 Expected Dividend (D1) = Current divided *(1+g) = 2.25*(1+0.0375) = $2.33 per Share Using the formula: Fair Price = D1 /(Ke g) Here Ke= Expected rate of return = 14%=0.14 Hence Fair Price = 2.33 / (0.14-0.0375) = $22.73 Present value of Growth opportunity (PVGO) = ROI Required Rate of Return =15%-14% = 1% No 4 As the growth is perpetual, according to dividend discount model Price of share, P = Dividend/r-g = 15/14%-1% = $115.38 Present value of growth opportunities = P/r-g = $824 per share No 5 If plowback ratio increased, the dividend per share will fall as the result of which stock price which is discounted dividend will fall. As Kodak is not involved in digital photography, it will not be able to sustain its growth rate and will eventually lead to negative growth rate so the discounted cash flows will fall as the year's progress. As the result of this falling growth rate, their stock price will fall & thus this will result in lower present value of growth opportunitiesStep by Step Solution
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