Question

# Omni Telecom is trying to decide whether to increase its cash dividend immediately or use the...

Omni Telecom is trying to decide whether to increase its cash dividend immediately or use the funds to increase its future growth rate.

 P0 = D1 Ke − g

P0 = Price of the stock today
D1 = Dividend at the end of the first year
D1 = D0 × (1 + g)
D0 = Dividend today
Ke = Required rate of return
g = Constant growth rate in dividends

D0 is currently \$3.20, Ke is 11 percent, and g is 6 percent.
Under Plan A, D0 would be immediately increased to \$3.60 and Ke and g will remain unchanged.
Under Plan B, D0 will remain at \$3.20 but g will go up to 7 percent and Ke will remain unchanged.

a. Compute P0 (price of the stock today) under Plan A. Note D1 will be equal to D0 × (1 + g) or \$3.60 (1.06). Ke will equal 11 percent, and g will equal 6 percent. (Round your intermediate calculations and final answer to 2 decimal places.)

b. Compute P0 (price of the stock today) under Plan B. Note D1 will be equal to D0 × (1 + g) or \$3.20 (1.07). Ke will be equal to 11 percent, and g will be equal to 7 percent. (Round your intermediate calculations and final answer to 2 decimal places.)

c. Which plan will produce the higher value?

• Plan A

• Plan B

a) Price of the stock today under Plan A:

P0= D1/ke-g

Given,

D0=3.6

g= 6%

ke = 11%

D1= D0*(1+g)

=3.6*(1+0.06)

=3.816

P0 = 3.816/11%-6%

= 3.816/5%

= 76.32

b) Price of stock today under Plan B:

Given

D0 =3.2

ke = 11%

g= 7%

D1= D0*(1+g)

= 3.2*1.07

= 3.424

P0 = D1/ke-g

= 3.424/11%-7%

= 3.424/4%

= 85.6

c) Price under plan A = 76.32

Price under plan B = 85.6

Since the price of stock under plan B is higher it generates higher value to the company. So Plan B should be selected.