Reference no: EM133056700

1. After the market closed on July 21, Google announced earnings of $51 per share in the last quarter. As a result Google's stock price closed at $1280 on July 22. Currently Google has expected quarterly earnings growth is 8%. Apparently, investors are bidding up the price on the assumption that Google's market value will exceed that of Microsoft in 3 years. Google's expected return is 1.25 times of that of Microsoft. Under this assumption, answer the following questions.

(a) Currently Microsoft is traded at $180 per share, with last quarter's earnings of $8.20 per share. Suppose Microsoft pays out 20% of its earning as dividend, and its quarterly earnings growth rate is 3%, what are the expected returns for each company?

(b) There are 8 Billion shares outstanding for Microsoft. Before earning announcement, investors were expecting Google to have the same total earning (who has 0.9 billion share outstanding) in 3 years as that of today's Microsoft at that time. What was the market expecting for Google's earning on July 17? Was Google's stock price higher than $1280 on July 21 before closing?

(c) If Google has decided to pay out 10% of its earnings starting next quarter for the next 2 years. Since the retained earnings drop, the growth rate will reduce to 7% per quarter. After that Google will pay out 20% of its earnings as dividends. Consequently, earning growth will further slow down to 3.85% per quarter forever. What should be the dividend next quarter and dividends in the first quarter in year 3 (in the 9th quarter)? [hint: although we have different assumptions, the expected returns remain the same]

(d) What should be Google's stock price, if they adopt the dividend policy? Is Google undervalued?