Omni Telecom is trying to decide whether to increase its cash dividend immediately or use the funds to increase its future growth rate.
P_{0} | = |
D_{1} |
K_{e} − g |
P_{0} = Price of the stock today
D_{1} = Dividend at the end of the first
year
D_{1} = D_{0} × (1 +
g)
D_{0} = Dividend today
K_{e} = Required rate of return
g = Constant growth rate in dividends
D_{0} is currently $3.10, K_{e}
is 10 percent, and g is 4 percent.
Under Plan A, D_{0} would be immediately
increased to $3.50 and K_{e} and g will
remain unchanged.
Under Plan B, D_{0} will remain at $3.10 but
g will go up to 5 percent and K_{e} will
remain unchanged.
a. Compute P_{0} (price of the stock today) under Plan A. Note D_{1} will be equal to D_{0} × (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 P_{0} (price of the stock today) under Plan B. Note D_{1} will be equal to D_{0} × (1 + g) or $3.10 (1.05). K_{e} will be equal to 10 percent, and g will be equal to 5 percent.
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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