Flatbush Shipyards is a no-growth company expected to pay a $12-pershare annual dividend into the distant future. Its cost of equity capital is 15 percent. The new president abhors the no-growth image and proposes to halve next year’s dividend to $6 per share and use the savings to acquire another firm. The president maintains that this strategy will boost sales, earnings, and assets. Moreover, he is confident that after acquisition, dividends in year 2 and beyond can be increased to $12.75 per share.
a. Do you agree that the acquisition will likely increase sales, earnings, and assets?
b. Estimate the per share value of Flatbush’s stock immediately prior to the president’s proposal.
c. Estimate the per share value immediately after the proposal has been announced.
d. As an owner of Flatbush, would you support the president’s proposal? Why or why not?
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