Question

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
K_e = Required rate of return
g = Constant growth rate in dividends

D₀ is currently $3.10, K_e is 10 percent, and g is 4 percent.
Under Plan A, D₀ would be immediately increased to $3.50 and K_e and g will remain unchanged.
Under Plan B, D₀ will remain at $3.10 but g will go up to 5 percent and K_e will remain unchanged.

a. Compute P₀ (price of the stock today) under Plan A. Note D₁ will be equal to D₀ × (1 + g) or $3.50 (1.04). K_e will equal 10 percent, and g will equal 4 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 $3.10 (1.05). K_e will be equal to 10 percent, and g will be equal to 5 percent.

Answer 1

a). Computing the Price of the Stock today (P0) under Plan A:-

where, D0= $3.50

g = growth rate= 4%

Ke = Required rate of return = 10%

P0 = $ 60.67

So, Price today under Plan A is $60.67

b). Computing the Price of the Stock today (P0) under Plan B:-

where, D0= $3.10

g = growth rate= 5%

Ke = Required rate of return = 10%

P0 = $ 65.1

So, Price today under Plan B is $65.1

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