Question 3

Sports plc expects this year earnings of 6 per share and plans to pay a 2.5 dividend per share, retaining the rest to reinvest in new projects with an expected return of 10% per year. Assuming that Sports plc will maintain the same dividend payout rate and return on new investments in the future and will not change the number of outstanding shares: a) What is the earnings growth rate according to the plans of Sports plc?

b) If the equity cost of capital for Sports plc is 8% per year, what is your estimate of its share price?

c) Suppose now that Sports plc examines an alternative plan according to which it would instead pay a 1.5 dividend per share and it would retain the remaining earnings for new investment projects that would yield an expected return of 12% per year. However, this alternative payout and investment policy would increase its riskiness, and hence its cost of equity capital would increase to 10% per year. If Sports plc maintains this lower payout rate in the future, what is your estimate of its share price according to this alternative plan? Would you advise the board of directors to adopt this alternative plan? Explain your answer.

Please, type it, as it is hard to understand handwriting.