Question

Oswego Plumbing Works​ (ticker: OPW) just announced that it will cut next​ year's dividend, Upper D 1D1​, from $ 2.25$2.25 to $ 1.40$1.40 per share and the firm will use the extra funds to expand operations. Prior to this​ announcement, OPW's dividends were expected to grow at 55​% per year and​ OPW's common stock was trading at a price of $ 25.00 to $25.00 /share. With the new​ expansion, OPW's dividends are expected to grow at 10​% per year indefinitely.

Assuming the overall risk of the firm is unchanged by this​ expansion, the value of one share of OPW after the announcement is closest​ to:

A.

$ 56.25$56.25

B.

$ 15.56$15.56

C.

$ 25.00$25.00

D.

$ 35.00$35.00

Answer 1

OPW's Dividend next year is cut from $ 2.25 to $ 1.40

Prior to dividend cut growth rate was = 5% per year

After dividend cut is expected to be = 10% pe year

Prior to dividend cut share price Was = $25.0

Since, the overall risk remain the same after dividend cut, we will calculate Required return of Equity (ke) from the information given before the dividend cut:-

D1 = $2.25

P0 = $25.00

g = 5%

Ke = 14%

As, the risk remain the same, Ke will be same after dividend Cut.

Now, Calculatig the Price of OPW after Dividend cut:-

D1 = $1.40

g = 10%

ke = 14%

P0 = $35

So, Value of share of OPW is $ 35

Hence, option D

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