NPI, an unlevered firm, has an ongoing policy of reinvesting half its earnings and paying out

the rest. Next year, NPI expects net income of $16 million. Its cost of equity capital is 12%.

a. If NPI earns a 16% return on investment in perpetuity on the funds reinvested (i.e., ROI =

16%), what is the growth rate and value of NPI?

b. Hypothetically, if the firm reinvested none of its earnings and always paid 100% of

earnings as dividends, what would be the value?

c. How much of firm value in part a is attributable to growth from the reinvestment?

Suppose NPIs return on investment on all retained earnings reinvested were 12% instead of

the 16% assumed in the previous problem. (Continue to assume year 1 earnings of $16

million.)

a. What is the new value of NPI?

b. If the dividend payout ratio were increased from 0.50 to 0.75, what would happen to the

growth rate and value of NPI?

c. Suppose the payout ratio were decreased to 0.25, how would growth and value change?

d. What would happen to growth and value if the firm stopped reinvesting any earnings and

instead paid out all earnings as dividends (100% payout ratio or 0% retention ratio)?