Management action and stock valueREH Corporation\'s most recent dividend was $ 2

Question

Management action and stock valueREH Corporation's most recent dividend was $ 2.03 per share, its expected annual rate of dividend growth is 5%, and the required return is now 15%. A variety of proposals are being considered by management to redirect the firm's activities. Determine the impact on share price for each of the following proposed actions.

a.Do nothing, which will leave the key financial variables unchanged.

b.Invest in a new machine that will increase the dividend growth rate to

6%

and lower the required return to

14%.

c.Eliminate an unprofitable product line, which will increase the dividend growth rate to

7%

and raise the required return to

18%.

d.Merge with another firm, which will reduce the growth rate to

4%

and raise the required return to

19%.

e. Acquire a subsidiary operation from another manufacturer. The acquisition should increase the dividend growth rate to

9%

and increase the required return to

18%

Explanation / Answer

REH Corporation a.Do nothing, which will leave the key financial variables unchanged. Po = $2.03(1.05)/ (.15 - .05) = $21.32 b. Invest in a new machine that will increase the dividend growth rate to 6% and lower the required return to 14%. Po = $2.03 (1.06)/ (.14 - .06) = $26.90 c. Eliminate an unprofitable product line, which will increase the dividend growth rate to 7%, and raise the required return to 18%. Po = $2.03(1.07) /(.18 - .07) = $19.74 d. Merge with another firm, whch will reduce the growth rate to 4% and raise the required return to 19%. Po = $2.03 (1.04)/(.19 - .04) = $14.07 e. Acquire a subsidiary operation from another manufacturer. The acquisition should increase the dividend growth rate to 9% and increae the required return to 18%. Po = $2.03 (1.09)/ (.18 - .09) = $24.59 The best alternative in terms of maximizing share price is b.

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