The stock of NorthPoint Corporation is currently selling for $10 per share. Earnings per share in the coming year are expected to be $2. The company has a policy of paying out 50% of its
earnings each year in dividends. The rest is retained and invested in projects that earn a 20% rate
of return per year. This situation is expected to continue indefinitely.
a. Assuming the current market price of the stock reflects its intrinsic value as computed using
the constant-growth discounted dividend model (DDM), what rate of return do NorthPoint’s
investors require?
b. By how much does its value exceed what it would be if all earnings were paid as dividends
and nothing were reinvested?
c. If NorthPoint were to cut its dividend payout ratio to 25%, what would happen to its stock
price?
d. What if NorthPoint eliminated the dividend