Summit system has an equity cost of capital of 11%, will pay a dividendof $1.5 i
ID: 2720005 • Letter: S
Question
Summit system has an equity cost of capital of 11%, will pay a dividendof $1.5 in one year and its dividends had been expected to grow by 6% per year. you read in the paper that summit has revised itsgrowth prospects and nowexpects its dividends to grow at a rate of 3% per year forever.
a. what is the drop in the value of a share of summit system 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?
Explanation / Answer
Price of the stock = Dividend/cost of capital - growth rate
= 1.5/ 11% - 6%
= 1.5/5%
= $ 30
At growth rate of 3%
stock price = 1.5 / 11% - 3%
= 1.5 / 8%
= $ 18.75
Drop in the value = $ 30 - $ 18.75 = $ 11.25
The price would be around $ 18.75 because market rate would adjust the price of the stock according to the growth rate.
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