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 $2.80, K_{e}
is 12 percent, and g is 5 percent.
Under Plan A, D_{0} would be immediately
increased to $3.40 and K_{e} and g will
remain unchanged.
Under Plan B, D_{0} will remain at $2.80 but
g will go up to 6 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 $3.40 (1.05). K_{e} 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 P_{0} (price of the stock today) under Plan B. Note D_{1} will be equal to D_{0} × (1 + g) or $2.80 (1.06). K_{e} 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?
Plan B
Plan A
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 | |||||
a. | |||||
Computer P0 under plan A | |||||
P0 | 3.40*(1.05)/(0.12-0.05) | ||||
P0 | 3.57/0.07 | ||||
P0 | $51.00 | ||||
b. | |||||
Computer P0 under plan B | |||||
P0 | 2.80*(1.06)/(0.12-0.06) | ||||
P0 | 2.968/0.06 | ||||
P0 | $49.47 | ||||
c. | |||||
Plan A would provide higher stock price | |||||
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