Solar Inc. pays a current dividend of $2.50 per shareannually. This dividend is

Question

Solar Inc. pays a current dividend of $2.50 per shareannually. This dividend is expected to grow at the rate of 3.25% per year forthe foreseeable future. Rating LLC has given Solar Inc. a beta score of 1.05.The risk-free rate of return is currently 1.25% and is expected to remain therefor some time. The current market rate of return is 5.625%. Answer the following questions: a. What price would you expect Solar Incorporated’sstock to sell? b. If the risk-free rate of return increases to3.5% and the market rate of return changes to 7.875%, what impact will thathave on the expected price of Solar Inc.’s stock? c. Solar Inc. is anticipating a significant mergerand acquisition to enhance their productivity and reduce their fixed costs. Asa result of this acquisition, management expects their beta to drop to .95.Their dividend growth rate is expected to increase to 4% and remain thereindefinitely. Assuming that all other conditions used in “a” remain the same,would you recommend this acquisition to the board of directors?

Explanation / Answer

Case Stock Price 1 Dividend 2.58125 99.51807 Cost of Equity 5.84375 2 Dividend 2.58125 53.29032 Cost of Equity 8.09375 3 Dividend 2.6 184.8889 YES they should go for acquisition Cost of Equity 5.40625

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