a) Ergon Inc. expects to have £125 million in earnings at the end of the year and earnings are expected to grow at 6% annually.The firm does not pay any dividends, but it intends to use 25% of its earnings for stock repurchases. Ergon’s cost of equity is 15% and it has 25 million shares outstanding. Calculate Ergon’s stock price. [7 marks]
b) ABC Corporation expects to have earnings per share of £6 next year. Rather than reinvest these earnings and grow, the firm plans to pay out all of its earnings as a dividend. With these expectations, of no growth, ABC’s current share price is £60. Suppose ABC could cut its dividend payout rate to 75% next year and use the retained earnings to open new stores. The return on its investment in these stores is expected to be 12%. Assuming its equity cost of capital and the new growth rate remain unchanged, what effect would this new policy have on ABC’s stock price? [7 marks] Get Finance homework help today
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