Problem 5: Use what you know about the situation and the theory to come up with an answer that…

Problem 5: Use what you know about the situation and the theory to come up with an answer that…

Problem 5:Use what you know about the situation and the theory to come up with an answer that seems appropriate according to the theory. Do not focus on having all exact numbers to accomplish everything. The final number is not what is important. What does each factor stand for and what happens if one chooses one of the possibilities for each factor individually?

What each variable stands for is known in problem 5:

· b = retention ratio.

· E1 = earnings next year.

· ROE = return on equity.

· Dividend-payout ratio = 1 minus b.

· P0 = dividend next year; the earnings next year times 1 minus the retention ratio.

· Rs = sustainable growth rate; the return on equity times the retention ratio.

Eight years in from the start of the company, the profit is \$42 million from the sale of a fixed asset.

· What happens to P0 and ROE if all other factors remain steady and b goes up or down?

· What effect does the one-time influx of \$42 million have on the formula?

Problem 5: Use what you know about the situation and the theory to come up with an answer that…