Question

The dividend-growth model, De(1+9) k-9 V= suggests that an increase in the dividend growth rate will increase the value of a stock. However, an increase in the growth may require an increase in retained earnings and a reduction in the current dividend. Thus, management may be faced with a dilemma: current dividends versus future growth. As of now, investors réquired return is 12 percent. The ourrent dividend is $1.1 a share and is expected to arow annually by 7 percent, so the current market price of the stock is $23.54. Management may make an investment that will increase the firm's growth rate to 10 percent. but the investment will require an increase in retained earnings, so the firm's dividerid must be cut to $0.9 a share. Should management make the investment and reduce the dividend? Round your answer to the nearest cent. make the investment and decrease the dividend. so the management-Select The value of the stock to eect

the value of the stock rises or declines
so the management should not or should make the investment and decreased the dividend

Answer 1

Given : New policy details Dividend (Do) Growth (g) Required Rate (r) 0.9 10% 12% 23.54 $ Current price under existing policy Solution: Calculate Stock price Current Price = = Do(1+g) (r- g) 0.99 2% 49.50 = $ The value of stock rises to $ 49.5, so the management should make the investment and decrease the dividend.