Sunnyfax Publishing pays out all its earnings and has a share price of $38.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 12%.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 12%. Assuming the equity cost of capital remains the same, the share price is calculated as $2.00 / (equity cost of capital - 0.12). Given the original dividend of $3.00 and share price of $38, the equity cost of capital is $3.00 / $38 = 0.0789 or 7.89%. The new share price is $2.00 / (0.0789 - 0.12) = $50.00.

Sunnyfax Publishing Pays Out All Its Earnings and Has a Share