Problem
Northsea Inc. is an all-equity firm and it has been paying out all its earnings as dividend. Northsea's cost of capital is 10%, and its last Earnings Per Share is $4.50.
(i) Assuming Northsea keeps paying all its earnings as dividend. What is the value of Northsea Inc. stock based on the dividend discount model?
(ii) Northsea just announces that it will change it investment and dividend policy. It will continue to pay all its earnings as dividend next year but it will only distribute 70% of its earnings after next year. The retained earnings will be reinvested in projects with expected rate of return of 12%. What effect would this policy have on Northsea's stock price (find the price)?