Flinders Corporation's shares currently cost $32.00,and it has 80 million shares outstanding.If it pays out 70% of its earnings in total and its equity cost of capital is 10 percent,what are Flinders' earnings,given that these earnings are expected to grow by 5% per year in the future?

Question

Quizplus · Accepted Answer

The value of Flinders Corporation can be calculated using the dividend discount model for a firm that pays out a constant fraction of its earnings and whose earnings grow at a constant rate. The model simplifies to $ P_0 = \frac{DPS_1}{r - g} $, where $P_0$ is the current price, $DPS_1$ is the dividend per share next period, $r$ is the cost of equity, and $g$ is the growth rate of dividends (and earnings). Given that the firm pays out 70% of its earnings, the payout ratio is 0.7, and the growth rate $g$ is 5% or 0.05. The cost of equity $r$ is 10% or 0.10. The market capitalization of the firm is $32.00 * 80 million shares = $2,560 million. To find the earnings, we rearrange the formula to solve for $EPS_1$, knowing that $DPS_1 = EPS_1 \times payout\ ratio$. However, since we're looking for total earnings, not per share, we'll work with total dividends and total earnings. The formula becomes $ Market\ Capitalization = \frac{Total\ Dividends}{r - g} $. Given that $Total\ Dividends = Earnings \times Payout\ Ratio$, we can solve for Earnings as follows: $Earnings = \frac{Market\ Capitalization \times (r - g)}{Payout\ Ratio}$.Substituting the given values: $Earnings = \frac{2560 \times (0.10 - 0.05)}{0.70}$ = $\frac{2560 \times 0.05}{0.70}$ = $\frac{128}{0.70}$ = $182.86 million.Therefore, the correct answer is D, $182.86 million.

Flinders Corporation's Shares Currently Cost $32