3) SleepEZ hotels are entering into a 4 year remodeling and expansion project. T
ID: 2629758 • Letter: 3
Question
3) SleepEZ hotels are entering into a 4 year remodeling and expansion project. The company doesnt expect to pay any dividends for the next four years. SleepEZ is considering 2 options for the expansion: a. Option#1: begin paying dividends of $6 at the end of year 5. Management expects dividends to grow at a rate of 9% forever. b. Option#2: pay a smaller dividend of $4 at the end of year 5 for 2 years, then under this option, dividends will grow at a rate of 12% forever. As a shareholder, if you require a return of 17% on your investments, which option would you prefer? Show your work
Explanation / Answer
a. Option#1:
Value of the stock = (6/(17%-9%))/1.17^4= 40.02
b. Option#2:
value of the stock = 4/1.17^5 +4/1.17^6 + (4*1.12/(17%-12%))/1.17^6= 38.31
Value of the stock is higher in Option 1. Hence as an investor, I would choose Option1
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