North Great Timber Company will pay a dividend of $1.50 a share next year. After

Question

North Great Timber Company will pay a dividend of $1.50 a share next year. After this, earnings and dividends are expected to grow at a 9 percent annual rate indefinitely. Investors currently require a rate of return of 13 percent. The company is considering several business strategies and wishes to determine the effect of these strategies on the market price per share of its stock.
a. Continuing the present strategy will result in the expected growth rate and required rate of return stated above.
b. Expanding timber holdings and sales will increase the expected dividend growth rate to 11 percent but will increase the risk of the company. As a result, the rate of return required by investors will increase to 16 percent.
c. Integrating into retail stores will increase the dividend growth rate to 10 percent and increase the required rate of return to 14 percent.
From the standpoint of market price per share, which strategy is best?

Explanation / Answer

North Great Timber Company will pay a dividend of $1.50 a share next year. After this, earnings and dividends are expected to grow at a 9 percent annual rate indefinitely. Investors currently require a rate of return of 13 percent. The company is considering several business strategies and wishes to determine the effect of these strategies on the market price per share of its stock.
a. Continuing the present strategy will result in the expected growth rate and required rate of return stated above.
Market price per share =D/(R-g)=1.50(0.12-0.08)=$37.50


b. Expanding timber holdings and sales will increase the expected dividend growth rate to 11 percent but will increase the risk of the company. As a result, the rate of return required by investors will increase to 16 percent.
Market price per share=D/(R-g)=1.50(0.15-0.10)=$30.00

c. Integrating into retail stores will increase the dividend growth rate to 10 percent and increase the required rate of return to 14 percent.

Market price per share =D/(R-g)=1.50(0.13-0.09)=$37.50
From the standpoint of market price per share, which strategy is best?
strategy C is best

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