Question

1. Summit Systems will pay a dividend of $1.43 this year. If you expect​ Summit's dividend to grow by 6.7% per​ year, what is its price per share if the​ firm's equity cost of capital is 10.5%​?

2. Cooperton Mining just announced it will cut its dividend from $4.03 to $2.73 per share and use the extra funds to expand. Prior to the​ announcement, Cooperton's dividends were expected to grow at a 3.3% ​rate, and its share price was $49.63. With the planned​ expansion, Cooperton's dividends are expected to grow at a 4.6% rate. What share price would you expect after the​ announcement? (Assume that the new expansion does not change​ Cooperton's risk.) Is the expansion a good​ investment?

Answer 1

A]

price per share = expected dividend / (cost of equity - growth rate)

price per share = $1.43 / (10.5% - 6.7%)

price per share = $37.63

B]

cost of equity = (expected dividend / current share price) + growth rate

cost of equity = ($4.03 / $49.63) + 3.3%

cost of equity = 11.42%

share price after announcement = expected dividend / (cost of equity - growth rate)

share price after announcement = $2.73 / (11.42% - 4.6%)

share price after announcement = $40.03

Yes, it is a good investment as the value per share is higher with the expansion