JRN enterprises just announced that it plans to cut its dividend from $2.25 to $
ID: 2759897 • Letter: J
Question
JRN enterprises just announced that it plans to cut its dividend from $2.25 to $1.30 per share and use the extra funds to expand its operations. Prior to this announcement, JRN's dividends were expected to grow at 5% per year and JRN's stock was trading at $25.50 per share. With the new expansion, JRN's dividends are expected to grow at 10% per year indefinitely. Assuming that JRN's risk is unchanged by the expansion, the value of a share of JRN after the announcement is closest to _________. (Note: Compute the cost of capital, r, first then compute the current price).
Explanation / Answer
Answer:
Cost of Capital (before announcement) = Next Year Expected Dividend / Curremt Market PRice per SHare + Growth Rate
= ($2.25 x 1.05) / $25.50 + 0.05 = $2.3625 / $25.50 + 0.05 = 0.0926 + 0.05 = 0.1426 or 14.26%
Value of Share of JRN after the announcement = Next Year Expected Dividend / Cost of Capital - Growth
= $1.30 / 0.1426 - 0.10 = $30.516 or $30.52
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