Dividends and earnings per share

Stelco Steel plans to pay a dividend of $3 this year. The company has an expected earnings growth rate of 4% per year and an equity cost of capital of 10%.

a. Assuming that Stelco’s dividend pay-out rate and expected growth rate remain constant, and that the firm does not issue or repurchase shares, estimate Stelco’s share price.

b. Suppose Stelco decides to pay a dividend of $1 this year and to use the remaining $2 per share to repurchase shares. If Stelco’s total payout rate remains constant, estimate Stelco’s share price.

c. If Stelco maintains the dividend and total payout rate given in part (b), at what rates are Stelco’s dividends and earnings per share expected to grow?

Saskatchewan River Enterprises (SRE) has $500 million in debt and 20 million shares of equity outstanding. Its excess cash reserves are $15 million. SRE is expected to generate $200 million in free cash flows next year with a growth rate of 2% per year in perpetuity. SRE’s cost of equity capital is 12%.

a. What is SRE’s stock price?

b. After analyzing the company, you believe that the growth rate should be 3% instead of 2%. Assume debt and cash values do not change. What should the stock price be given the higher growth rate?

c. Given the growth rate change from 2% to 3%, how can you calculate the change in stock price without calculating the amounts in (a) or (b) above?


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