The Firm\'s dividends have been growing at a sustained 16% annual rate. The firm

Question

The Firm's dividends have been growing at a sustained 16% annual rate. The firm's required rate of return is 17% and the Board's planned next dividend is $2.10 (annualized). The company is presented with seeral opportunities that requore funding. One is to raise this funding by increasing the retained earnings and slowing the growth rate of the dividends to 15%. This will not change the required return(17%) or the next dividend($2.10). Many directors assert the small (1%) change in dividend growth rate(with no reduction in dividends)will have a negligible impact on shareholder value and want to proceed immediately.
a. Determine the present Hennesset stock price.
b. Determine the stock price if the alternative is pursued.
c. Should the firm pursue this course of action? Why/Why not?

Explanation / Answer

a) P0 = [ Dx / (r-g) ] = 2.1 / (.17-.16) = $210 b) PO = [ Dx / (r-g) ] = 2.1 / (.17-.15) = $105 c) If you are decreasing the growth rate of the dividends, then the stock price will decrease as well. Therefore, the firm should not pursue this course of action.

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