(8 points) Foot Locke r expects to have earnings per share of $4 in the coming y

Question

(8 points) Foot Locke r expects to have earnings per share of $4 in the coming year. The firm plans to pay out all its earnings as dividends. With these expectations, Foot Locker current share price is $40. Suppose Foot Locker could cut its dividend payout rate to 60% for the foreseeable future and use the retained earnings to open new stores. The return on equity of the company with these stores is expected to be 12%. Assuming cost of equity capital is unchanged. what would be Foot Locker's new stock price? What are the present value of growth opportunities per share?

Explanation / Answer

Current Stock Price = $40

Expected earnings = $4.

If comapny paysout all its earnings as dividend then required rate of return is calculated below:

Required rate of return = $4 / $40

= 10%

Required rate of return is 10%.

Now, if payout ratio = 60%

Expected dividend = $4.00 × 60%

= $2.40.

Expected dividend is $2.40.

Retention ratio = 40%

Return on equity = 12%

Growth rate = 12% × 40%

= 4.80%.

Now Stock price of comapny if it pays 60% of earnings as dividend is calculated below:

Stock price = $2.40 / (10% - 4.80%)

= $2.40 / 5.20%

= $46.15.

So, Stock price of comapny if it pays 60% of earnings as dividend is $46.15.

Present value of growth opportunity = $46.15 - $40

= $6.15

Present value of growth opportunity is $6.15.

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