Reference no: EM13200928

In addition to evaluating internal investment proposals, you must also manage external relations with equity (stock) investors.  One of you tasks is to manage the firm's dividend policy, via deciding upon the level of dividends to be paid out next year (assume that the dividends are paid once a year), and providing guidance to investors (via disclosures, and public discussions) of the expected growth rate of the dividends thereafter.

Assume Namrog's current financial situation is as follows:

Book value of equity per share (per the accountants) = €47.00 / share

Market value of equity per share (per the Stock Market) = €62.00 / share

Market value of equity per share (per the Main street liquidation value) = €55.00 / share

Number of shares outstanding = 35 million.

The return on equity (ROE) is currently 9% per year, and this level is expected to occur forever. For our purposes, assume that ROE is defined as the free cash flow (FCF), divided by the appropriate measure of equity.

The appropriate discount rate is determined according to the CAPM, with information on beta, etc given in Part I.

The current dividend policy specifies that 40% of the Namrog's FCF will be paid out as dividends, in each year.

Determine, and discuss: Support your comments with computations whenever possible.

1. What do you expect the dividend (per share) to be one year from today? Explain how this dividend is generated.

2. Should you use the CAPM or the WACC as the discount rate for pricing the stock?  Why?

3. What do you think the fair value of the stock price (per share) is currently (based on a dividend discount model)? How does this compare to the actual stock price? 

4. By what percentage is the stock price overvalued or undervalued? What does this mean to an investor who is considering purchasing the stock, or to an investor who already owns the stock?

You are also considering changing the dividend policy slightly, from a 40% payout policy, to either a 30% payout policy or a 50% payout policy?

Please discuss:  Support your comments with computations whenever possible.

5. What is the best level of the dividend policy that should be adopted going forward, 30% or 50% payout rates? Why?

A colleague argues that dividend levels signal the health of the firm, and that changing the firm's dividend policy might have effects that reduce, or possibly enhance the value of the stock. Furthermore he claims that these signaling effects have the capacity to counteract the price impact you expect from your answer in the prior Question.

Please discuss:  Support your comments with computations whenever possible.

6. How might this signaling idea affect your dividend policy decision in the prior Question? With this signaling argument in mind, what do you think is the best dividend policy for Namrog? Why?