Question

Management action and stock value   REH​ Corporation's most recent dividend was $ 2.26 per​ share, its expected annual rate of dividend growth is 55​%, 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 99​% and lower the required return to 13%.

c.  Eliminate an unprofitable product​ line, which will increase the dividend growth rate to 99​% and raise the required return to 16%.

d.  Merge with another​ firm, which will reduce the growth rate to 44​% and raise the required return to 16​%.

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

a]

current share price = recent dividend * (1 + growth rate) / (required return - growth rate)

current share price = $2.26 * (1 + 5.5%) / (15% - 5.5%)

current share price = $25.10

b]

share price = recent dividend * (1 + growth rate) / (required return - growth rate)

share price = $2.26 * (1 + 9.9%) / (13% - 9.9%)

share price = $80.12

c]

share price = recent dividend * (1 + growth rate) / (required return - growth rate)

share price = $2.26 * (1 + 9.9%) / (16% - 9.9%)

share price = $40.72

d]

share price = recent dividend * (1 + growth rate) / (required return - growth rate)

share price = $2.26 * (1 + 4.4%) / (16% - 4.4%)

share price = $20.34

e]

share price = recent dividend * (1 + growth rate) / (required return - growth rate)

share price = $2.26 * (1 + 9%) / (16% - 9%)

share price = $35.19