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The CO Co estimates that it can produce a constant earnings flow of 0.5 per share for the foreseeable future (no growth). The company pays
The CO Co estimates that it can produce a constant earnings flow of 0.5 per share for the foreseeable future (no growth). The company pays the earnings in full as cash dividends. The beta of the CO Cos stock is 1.2. The risk-free rate is 4%, and the average return on the market index is 8%. The corporate and investor tax rates are zero.
- What is the price per share of the CO Cos stock?
- Suppose CO Co plans to retain 40% of the earnings per share to reinvest in its business. The investments have the same beta as the equity and earn a return of 6.8%. The company pays the remaining 60% as cash dividends. What are the share price, dividend yield, and dividend growth after implementing the reinvestment plans?
- Now suppose the company could improve the return on the reinvested earnings from 8.6% to 9%. What are the price per share, the dividend yield, and the growth in dividends now?
- Do the reinvestment plans in question (b) and (c) create value? Explain why the answers have no bearing on Mrs theory of dividend policy irrelevance.
(20 marks)
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