Question

Cooperton Mining just announced it will cut its dividend from $4 to $2.50 per share and use the extra funds to expand. Prior to the announcement, Cooperton’s dividends were expected to grow at a 3% rate, and its share price was $50. With the new expansion, Cooperton’s dividends are expected to grow at a 5% rate.

a. What share price would you expect after the announcement?

b. (Assume Cooperton’s risk is unchanged by the new expansion.) Is the expansion a positive NPV  investment?

**please list out step by step actions, please show the formulas used, please DONT USE excel**

Answer 1

a. The cost of equity is computed as shown below:

= (Dividend / share price) + growth rate

= ($ 4 / $ 50) + 0.03

= 11% or 0.11

New price is computed as follows:

= Dividend / (cost of equity - growth rate)

= $ 2.50 / (0.11 - 0.05)

= $ 41.67 Approximately

b. As can be seen by cutting the dividend, the price of the share falls, hence this is not a positive NPV investment.

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