Question

wyatt oil, an all-equity financed firm, has just reported eps of $4.00 per share. despite an economic downturn, wyatt is confident regarding its current investment opportunities, but due to the current financial crisis, wyatt does not wish to fund these investments externally. wyatt's board has therefore decided to suspend its stock repurchase plan and cut its dividend to $1 per share (from its current level of $2 per share) and retain these funds instead. the firm just paid its current dividend of $1.00 per share and expects to keep its dividend at $1 per share next year as well. in subsequent years, it expects its growth opportunities to slow, and it will still be able to fund its growth internally with a target 40% dividend payout ratio, and reinitiating its stock repurchase plan for a total payout rate of 60%. all dividends and repurchases occur at the end of each year. wyatt's existing operations are expected to generate the current level of earnings per share in the future. assume that the return on new investments is 16% and that reinvestments will account for all future earnings growth. wyatt's current equity cost of capital is 12%. wyatt's current stock price is closest to: group of answer choices $51.23. $54.00. $49.11. $61.38.

Answer 1

To find the current stock price of Wyatt Oil, we would calculate the present value of future dividends and stock repurchases by considering the announced dividend cut and future payout ratio in conjunction with the company's current earnings per share, growth prospects from reinvestments at a 16% return, and the equity cost of capital of 12%. This involves using the Gordon Growth Model to capitalize the expected dividends, adjusted for future growth rates.

Step-by-step explanation:

To determine the current stock price of Wyatt Oil, we must calculate the present value (PV) of its future dividends and stock repurchases under the given equity cost of capital. This can be done by discounting the future payments to their present values. Wyatt Oil will pay dividends of $1 per share next year and thereafter expects to attain a 40% dividend payout ratio, with the remaining 60% potentially used for stock repurchases.

Given that Wyatt Oil's earnings per share (EPS) is $4.00, a 40% dividend payout ratio in the future implies dividends will be $1.60 per share (40% of $4.00). The remaining 60% suggests that the firm will be aiming to use the equivalent of $2.40 per share for stock repurchases. Assuming a constant EPS and a reinvestment return of 16%, it implies future growth in dividends and repurchases as reinvested earnings contribute to the firm's growth at this rate.

The firm's equity cost of capital is 12%. Since dividends are expected to grow at the rate of returns on new investments, the Gordon Growth Model can be applied where the expected permanent growth rate will be 16% (return on new investments). By using this model, we calculate the stock's price by the dividend capitalization approach, considering Wyatt's plan to cut its dividend to $1 next year and to keep it at that level for the foreseeable future, followed by growth corresponding with new investment returns.