Question

Management action and stock value   REH​ Corporation's most recent dividend was $ 1.98 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 8 ​% and lower the required return to 13 ​%.

c.  Eliminate an unprofitable product​ line, which will increase the dividend growth rate to 6 ​% and raise the required return to 16 % .

d.  Merge with another​ firm, which will reduce the growth rate to 2 ​% and raise the required return to 19 ​%.

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

	Share price per the constant dividend growth model = D0*(1+g)/(r-g)
	where
	D0 = Last dividend paid per share
	g = growth rate in dividends
	r = required return
	Using the above formula, share price is arrived at as below for
	each of the situations:
a)	Share price = 1.98*1.05/(0.15-0.05) =	$          20.79
b)	Share price = 1.98*1.08/(0.13-0.08) =	$          42.77
c)	Share price = 1.98*1.06/(0.16-0.06) =	$          20.99
d)	Share price = 1.98*1.02/(0.19-0.02) =	$          11.88
e)	Share price = 1.98*1.09/(0.16-0.09) =	$          30.83