Unit Case 2 Assessing the Impact of JTR Incorporated\'s Proposed Risky Investmen
ID: 2734625 • Letter: U
Question
Unit Case 2 Assessing the Impact of JTR Incorporated's Proposed Risky Investment on Its Stock Value 20 points possible Due June 21 On January 1, Angela Garcia, the chief financial officer for JTR Incorporated, was given the task of assessing the impact of a proposed risky investment on the firm's stock value. To perform the analysis, Angela gathered the following information on the firm's stock. During the immediately preceding 4 years, the annual dividend paid on the firm's common stock had grown from $2.45 to $3.00 (Do), a 7% growth rate. Ms. Garcia believes that without the proposed investment, the historical annual dividend growth rate will continue into the future. Currently the required rate of return on the common stock is 12%. Ms. Garcia's research indicates that if the proposed investment is undertaken, the annual grate of dividend growth will rise to 11% and the coming year's dividend will rise to $3.33 per share. She feels that in the best case, the dividend would continue to grow at this rate each year forever into the future. In the anticipated case, the 11% annual rate of dividend growth would continue for only two years, and then at the beginning of the third year the dividend growth rate would return to the 7% rate that was experienced over the past four years. In the worst case, the firm's growth rate will drop to zero, due to the use of valuable managerial resources in an unsuccessful venture. As a result of the increased risk associated with the proposed risky investment, the required rate of return on the common stock is expected to increase by 3% to an annual rate of 15%. This required rate of return applies regardless of which dividend growth outcome occurs. Armed with the preceding information, Angela must now assess the impact of the proposed risky investment on the market value of JTR Inc.' stockExplanation / Answer
Answer (a):
Dividend per share (Do) = $3
Growth rate of dividend (g) = 7%
Required rate of return(Ke) = 12%
Current value per share = Next dividend/(Ke - g)
= 3(1+0.07)/(0.12-0.07)
=3.21/0.05
=$64.20
Answer (b):
Growth rate of dividend(g) = 11%
Dividend(Do) = $3.33
Required rate of return(Ke) = 15%
Value per share = Next dividend/(Ke - g)
=3.33(1+0.11)/(0.15-0.11)
=3.6963/0.04
=$92.41
Answer ( c)
Growth rate of dividend(g) = 11% for 2 years
=7% for remaining years
Required rate of return(Ke) = 15%
Dividend(Do) = $3.33
Dividend(D1) =$3.33(1+0.11) = 3.70
Dividend(D2) =$ 3.70(1+0.11) = $4.11
Dividend(D3) = $4.11(1+0.07) = 4.40
Value per share = Dividend(D3)/(Ke - g)
=4.40/(0.15-0.07)
=$55
Answer(d)
Growth rate of dividend(g) = 0%
Dividend(Do) = $3.33
Required rate of return(Ke) = 15%
Value per share = Dividend(Do)/Ke
=3.33/0.15
=$66.60
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