Reference no: EM132978947

Carlisle plc has current year earnings of £10 per share. Under its current plans, it is just about to pay a dividend of £3.00 per share, retaining the rest to reinvest in new projects with an expected return on new investments of 10% per year. Assuming that Carlisle plc will maintain the same dividend payout rate and the same return on new investments in the future, and will not change the number of outstanding shares:

a) What is the earnings growth rate according to the plans of Carlisle plc under the current plan?

b) If the equity cost of capital for Carlisle plc is 10% per year, and we assume that its perpetual dividend growth rate will be the same as the earnings growth rate calculated in part a), what is your estimate of its current share price under the current plan?

c) Suppose now that Carlisle plc examines an alternative plan. In this plan, it would instead pay a £5.00 dividend per share, and would retain the remaining earnings for new investment projects. These new investment projects would yield an expected return of 16% per year. Assume that current year earnings remain at £10 per share. What is the earnings growth rate according to the plans of Carlisle plc under this alternative plan?

d) This alternative payout and investment policy would increase the risk of the company, and hence its cost of equity capital would increase to 12% per year. If Carlisle plc were to maintain this higher payout rate in the future, and assuming that its new perpetual dividend growth rate will be the same as its new earnings growth rate calculated in c), what is your estimate of its current share price according to this alternative plan?

e) Which of the two plans would you advise the management of Carlisle plc to follow?