Question

Omni Telecom is trying to decide whether to increase its cash dividend immediately or use the funds to increase its future growth rate.

   

P0	=	D1
		Ke − g

P₀ = Price of the stock today
D₁ = Dividend at the end of the first year
D₁ = D₀ × (1 + g)
D₀ = Dividend today
K_e = Required rate of return
g = Constant growth rate in dividends

D₀ is currently $2.90, K_e is 9 percent, and g is 6 percent.

Under Plan A, D₀ would be immediately increased to $3.30 and K_e and g will remain unchanged.
Under Plan B, D₀ will remain at $2.90 but g will go up to 7 percent and K_e will remain unchanged.

a. Compute P₀ (price of the stock today) under Plan A. Note D₁ will be equal to D₀ × (1 + g) or $3.30 (1.06). K_e will equal 9 percent, and g will equal 6 percent. (Round your intermediate calculations and final answer to 2 decimal places.)
Stock price for plan A =

b. Compute P₀ (price of the stock today) under Plan B. Note D₁ will be equal to D₀ × (1 + g) or $2.90 (1.07). K_e will be equal to 9 percent, and g will be equal to 7 percent. (Round your intermediate calculations and final answer to 2 decimal places.)
Stock price for plan B =

c. Which plan will produce the higher value?

	Plan A
	Plan B

Answer 1

a.

D1 = 3.30*(1+0.06) = 3.498

P0 = D1/(Ke-g) = 3.498/(0.09-0.06) = $116.60

b.

D1 = 2.90*(1+0.07) = 3.103

P0 = 3.103/(0.09-0.07) = $155.15

c.

Plan B has higher value.