The Dipthong Corporation has a current stock price of $50 per share. Next year, earnings will be $4 per share, and dividends will be $2 per share. There are currently 100 shares outstanding. There is no uncertainty. Under current policy, earnings per share for the company will grow at 8% per year forever. The appropriate discount rate is 12%. Assume no taxes and that all the other MM assumptions hold. Clearly, all the above numbers are consistent with a Gordon dividend growth model, since 50 = 2 / (.12-.08).

Suppose that Dipthong decides to switch from a 50% to a 100% dividend payout policy. It will keep its investment policy (its assets and real operations) unchanged, and will issue shares as necessary to accomodate the new dividend policy.

The Dipthong Corporation has a current stock price of $50 per share. Next year, earnings will be $4 per share, and dividends will be $2 per share. There are currently 100 shares outstanding. There is no uncertainty. Under current policy, earnings per share for the company will grow at 8% per year forever. The appropriate discount rate is 12%. Assume no taxes and that all the other MM assumptions hold. Clearly, all the above numbers are consistent with a Gordon dividend growth model, since 50 = 2 / (.12-.08).

Suppose that Dipthong decides to switch from a 50% to a 100% dividend payout policy. It will keep its investment policy (its assets and real operations) unchanged, and will issue shares as necessary to accomodate the new dividend policy.

Use the Gordon model to show that this policy will result in no change in the stock price. What is r, the discount rate? What is g, the growth rate of dividends per share? Explain why these things change.

Use the Gordon model to show that this policy will result in no change in the stock price. What is r, the discount rate? What is g, the growth rate of dividends per share? Explain why these things change.