Question

Dubai? Metro's stock price was at ?$100 per share when it announced that it will cut its dividend for next year from ?$10 per share to ?$6 per? share, with additional funds used for expansion. Prior to the dividend? cut, Dubai Metro expected its dividends to grow at a 4 percent? rate, but with the? expansion, dividends are now expected to grow at 7 percent. How do you think the announcement will affect Dubai? Metro's stock? price?

Answer 1

Rturn on Equity - Re

Current Price - P0

Next Year Dividend = D1

Div Growth = g

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Before Announcement

We know Re = D1/ P0 + g -------------Eq 1

= 10/100 +4% = 14%

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To have same kind of return there will be price chnage.

Now D1 has changed to 6 and g is changed to 7%

Rearranging Eq 1, we wil get

P0 = D1/ (Re - g) = $6 / (0.14 - 0.07) = $85.71

Hence, There will be price drop of ( 100 - 85.71)/100 = 14.28 % drop in share price.