A mature company on Beverage and food industry, with stable earning expects to have earnings per share (EPS) of 30 AED in the coming year and Its current stock price is 280 AED the management must decide between the following alternatives pay all of its earnings as dividends and abandon the new investment in Dubai or cut Its Dividend payout rate to 75% and implement the Dubai project. If the second policy is followed there is a divergence in the estimation of the return on new investment .
(i) Pay all its earnings as dividends. Because of the status of the company and its strength in the market, the CEO believes that cash flow from operations is sufficient to continue to reinvest in growth, though has to abandon Dubai project for next year, and decided to pay out all of its earnings to investors. Besides that, current economic conditions are week due to the crisis, and the CEO is more willing to pay dividends than to enter a program of share buybacks. In addition, there is a favorable tax environment since the 2003 act significantly changed the tax treatment of corporate dividends for most taxpayers.
(ii)cut its dividend payout rate to 75% on other hand, the company’s managers has negative expectations regarding the recent financial crisis and advise to cut dividends even if this is not consistent with its long-run growth in earnings. He believes that it is better to reinvest some of the earnings to open new stores in Dubai. A project that will last 2 years and hence . it is advisable to safeguard its financial reserves for future expenses. If the firm follows this program the return on investment is expected to be 17% suppose that the required rate of return is the same as calculated in question 2 above
(iii)Expected return on new investment is 9% rather than 17% financial crisis is severe and persist. The manager of the company estimates that in this case the return on the new investment will be 9% rather than 17%. Assume EPS= $6 and the required rate of return is unchanged.
(iV) Taking into consideration the market’s systematic risk. Our firm has a beta factor (systematic risk) quite low , equal to 0.67. This is expected as out firm belongs to Beverage and food industry. The economy’s risk –free rate is 6% and the market’s return is 10%
1-What is the dividend yield and the growth rate of the firm?
2-Calculate the required rate of return
3-what is the firm’s P/E ratio

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