Omni Telecom is trying to decide whether to increase its cash dividend immediately or use the funds to increase its future growth rate.
|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 $2.80, Ke is 12 percent, and g is 5 percent.
Under Plan A, D0 would be immediately increased to $3.40 and Ke and g will remain unchanged.
Under Plan B, D0 will remain at $2.80 but g will go up to 6 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 $3.40 (1.05). Ke will equal 12 percent, and g will equal 5 percent. (Round your intermediate calculations and final answer to 2 decimal places.)
Stock price for Plan A
b. Compute P0 (price of the stock today) under Plan B. Note D1 will be equal to D0 × (1 + g) or $2.80 (1.06). Ke will be equal to 12 percent, and g will be equal to 6 percent. (Round your intermediate calculations and final answer to 2 decimal places.)
Stock price for Plan B
c. Which plan will produce the higher value?
|Using the dividend growth model we can calculate price of stock today|
|P0 = D0*(1+g)/(Ke-g)|
|P0 is the price today|
|D0 is dividend paid today|
|g is growth rate|
|Ke expected return on stock|
|Computer P0 under plan A|
|Computer P0 under plan B|
|Plan A would provide higher stock price|
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