Question
VSKC Limited is an Australian mining company specialising in extracting rare earth materials. Its current earnings per share is $5 per share. It pays 50%
VSKC Limited is an Australian mining company specialising in extracting rare earth materials. Its current earnings per share is $5 per share. It pays 50% of its earnings as dividends. The growth rate for the firm is estimated by the CFO (you) as b(ROE), where b is the retention rate and ROE is the return on equity. a) Calculate the intrinsic value of the firm assuming that the firm is on a constant growth path. Its cost of equity (required rate of return) is estimated to be 15%. (3 marks) b) Due to a recent discovery of rare earth deposits in one of its mines, the CFO considers cutting the dividends by 50% and investing the extra cash in the firm. The CFO asks her assistant to estimate the new stock price under this assumption. What would the assistants estimate be? (5 marks) c) The assistant exclaims Gee, I never knew that cutting dividends could increase the stock price!. Is the assistant correct? How would you explain this to him (the assistant)? (4 marks) d) A high-net-worth investor who has invested in the company, is considering investing more money in the company. Would this make sense, given that the investor pays tax at the top end? (3 marks)
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