Question

ust announced that it plans to cut its dividend from $2.50 to $1.50 per share (next year) and use the extra funds to expand its operations. Prior to this announcement, Zeke's dividend growth rate was zero per year and Zeke's stock was trading at $25.00 per share. With the new expansion, JRN's dividends are expected to grow at 4% per year indefinitely. If Zeke’s risk is unchanged by the expansion, what is the value of a share of Zeke after the

Answer 1

Answer: $25.00

Explanation:

To calculate this we can use the Gordon Growth Model which can help in the calculation of stock value.

The formula is,

= D1 / r – g.

D1 = the annual expected dividend of the next year.

r = rate of return/ risk

g = the expected dividend growth rate

We would need to first find the risk/ rate of return, r which is the same in both cases.

We will use the previous year to find this risk meaning the growth rate will be 0.

Making r the subject we get,

r = [D1 / P0] + g

= (2.50 / 25) + 0

= 0.10

Now that we have the risk, we can use the same formula to calculate the value after the expansion.

Now we can plug it in,

= D1 / r – g

= 1.50/(0.10 - 0.04)

= 1.50 / 0.06

= $25.00

The stock price after the expansion is therefore $25.00

Please do react or comment if you need clarification.

Answer 2

Answer:

$25                                                                                                                                                                                                                

Explanation:

Market Value MV=?

Dividend next year D1=$1.5

Dividend curret year Do=2.5

Growth rate g=4%

Stock returns Ke=?

First we determine stock returns

MV=Do/Ke

Ke=2.5/25

Ke=10%

Now we can work out revised market value based on growth rate of 4%

MV=D1/(Ke-g)

MV=1.5/(.1-.04)

MV=25