Question

Summit Systems has an equity cost of capital of 10.0%​, will pay a dividend of $1.75 in one​ year, and its dividends had been expected to grow by 6.0% per year. You read in the paper that Summit Systems has revised its growth prospects and now expects its dividends to grow at a rate of 3.0% per year forever.

a. What is the drop in value of a share of Summit Systems stock based on this​ information?

b. If you tried to sell your Summit Systems stock after reading this​ news, what price would you be likely to​ get? Why?

The drop in value of a share of Summit Systems stock is _______ ​(Round to the nearest​ cent.)

b. If you tried to sell your Summit Systems stock after reading this​ news, what price would you be likely to​ get?

The price of a share would likely be ______ (Round to the nearest​ cent.)

​Why?  ​(Select the best choice​ below.)

A.You would receive $43.75 because when you bought the​ stock, the dividend growth rate was still 6.0%.

B.You would receive $25.00 because markets are efficient and would incorporate the information about the new growth rate immediately.

C.You would receive $43.75 if you act very quickly because it takes a day or two for markets to incorporate the information about the new growth rate.

D.You would receive a price between $25.00 and $43.75 because you should get a blend of the old and new growth rate of dividends.

Answer 1

1.

=1.75/(10%-3%)-1.75/(10%-6%)=18.75

2.

B.You would receive $25.00 because markets are efficient and would incorporate the information about the new growth rate immediately.