Question

Management action and stock value   REH​ Corporation's most recent dividend was $ 2.58 per​ share, its expected annual rate of dividend growth is 5​%, and the required return is now 15​%. A variety of proposals are being considered by management to redirect the​ firm's activities. Determine the impact on share price for each of the following proposed actions.

a. Do​ nothing, which will leave the key financial variables unchanged.

b. Invest in a new machine that will increase the dividend growth rate to 6​% and lower the required return to 12​%.

c. Eliminate an unprofitable product​ line, which will increase the dividend growth rate to 7​% and raise the required return to 16%.

d. Merge with another​ firm, which will reduce the growth rate to 11​% and raise the required return to 18​%.

e. Acquire a subsidiary operation from another manufacturer. The acquisition should increase the dividend growth rate to 9% and increase the required return to 16​%

Answer 1

Current Share Price = D0 *(1+ g)/ R - g = 2.58* (1+0.05) / (0.15-0.05) = $27.09
a) Share price would remain same at $27.09.
b)Share price would increase to = 2.58* (1+0.06) / (0.12-0.06) = $45.58
c) Share price would increase to = 2.58* (1+0.07) / (0.16-0.07) = $30.67
d) Share price would increase to = 2.58* (1+0.11) / (0.18-0.11) = $40.91
e) Share price would increase to = 2.58* (1+0.09) / (0.16-0.09) = $40.17
PROPOSAL (b) SHOULD BE IMPLEMENTED.