Reference no: EM133071815

Equity Valuation:

GilSo Corp. produces twidgets and sells them in a local market.  Its current book value per share (BVPS) is $100 and its current earnings per share (EPS) are $20. For many years this has been a stable, no-growth business and all profits have been paid out as dividends. The opportunity cost of capital is r = 15%. 

The business development manager at GilSo has analyzed the prospects for a new expansion and is very positive: "If we adopt this expansion strategy, we can basically grow by 10% per year in perpetuity, with the same return on equity (ROE)!" The executive board is really happy about this and agrees to expand. 

Assume that GilSo satisfies all the assumptions of the dividend growth model and that the expansion is financed by cutting future dividends and reinvesting earnings. 

1. What is GilSo's current stock price (before any decision is made on the expansion)? 
2. What is GilSo's ROE? 
3. By how much (in dollars) will GilSo need to cut its dividend in order to fund the expansion plan? 
4. How much will the stock price increase (in dollars) if GilSo adopts the expansion plan?  Why should the stock price increase?