Sunnyfax Publishing pays out all its earnings and has a share price of $37. In order to expand, Sunnyfax Publishing decides to cut its dividend from $3.00 to $2.00 per share and reinvest the retained funds. Once the funds are reinvested, they are expected to grow at a rate of 13%. If the reinvestment does not affect Sunnyfax's equity cost of capital, what is the expected share price as a consequence of this decision?

Question

Quizplus · Accepted Answer

The expected share price can be calculated using the Gordon Growth Model. The new dividend is $2.00, and the growth rate is 13%. Assuming the cost of equity remains the same, the share price is calculated as $2.00 / (0.13 - 0.08) = $52.38.

Sunnyfax Publishing Pays Out All Its Earnings and Has a Share