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 $2.40, K_{e}
is 13 percent, and g is 5 percent.
Under Plan A, D_{0} would be immediately
increased to $3.00 and K_{e} and g will
remain unchanged.
Under Plan B, D_{0} will remain at $2.40 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 $3.00 (1.05). K_{e} will equal 13 percent, and g will equal 5 percent. (Round your intermediate calculations and final answer to 2 decimal places.)
b. Compute P_{0} (price of the stock today) under Plan B. Note D_{1} will be equal to D_{0} × (1 + g) or $2.40 (1.06). K_{e} will be equal to 13 percent, and g will be equal to 6 percent. (Round your intermediate calculations and final answer to 2 decimal places.)
c. Which plan will produce the higher value?
Plan B
Plan A
a)
Year 1 dividend = 3 (1.05) = 3.15
Price of stock today = Year 1 dividend / required rate - growth rate
Price of stock today = 3.15 / 0.13 - 0.05
Price of stock today = 3.15 / 0.08
Price of stock today = $39.38
b)
Year 1 dividend = 2.4 (1.06) = 2.544
Price of stock today = Year 1 dividend / required rate - growth rate
Price of stock today = 2.544 / 0.13 - 0.06
Price of stock today = 2.544 / 0.07
Price of stock today = $36.34
c)
plan A has the higher value
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