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 |

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