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QuestionNorth Great Timber Co. plans a \$1.50 dividend next year, growing at 9%. Analyze price impacts of three strategies.

Studdy Solution

STEP 1

Assumptions1. The dividend per share next year is 1.50.Thecurrentgrowthrateofearningsanddividendsis91.50. The current growth rate of earnings and dividends is9%<br />3. The current required rate of return by investors is13%<br />4. The company is considering several business strategies that could alter the growth rate and required rate of return5. The price of a share of stock in a company that pays dividends is calculated using the Gordon Growth Model=r−g = \frac{}{r - g}$where = price of the stock = dividend per share expected in the next yearr = required rate of returng = growth rate of dividends

STEP 2

First, we calculate the current price of the stock using the Gordon Growth Model and the current values for the dividend, required rate of return, and growth rate.
=r−g = \frac{}{r - g}

STEP 3

Substitute the given values into the equation=$1.500.13−0.09 = \frac{\$1.50}{0.13 -0.09}

STEP 4

Calculate the current price of the stock=$1.500.04=$37.50 = \frac{\$1.50}{0.04} = \$37.50

STEP 5

Next, we calculate the price of the stock under the first alternative business strategy, where the dividend growth rate increases to11% and the required rate of return increases to16%.
=r−g = \frac{}{r - g}

STEP 6

Substitute the new values into the equation=$1.500.16−0.11 = \frac{\$1.50}{0.16 -0.11}

STEP 7

Calculate the price of the stock under the first alternative business strategy=$1.500.05=$30.00 = \frac{\$1.50}{0.05} = \$30.00

STEP 8

Finally, we calculate the price of the stock under the second alternative business strategy, where the dividend growth rate increases to10% and the required rate of return increases to14%.
=r−g = \frac{}{r - g}

STEP 9

Substitute the new values into the equation=$.50.14−. = \frac{\$.50}{.14 -.}

STEP 10

Calculate the price of the stock under the second alternative business strategy=$.500.04=$37.50 = \frac{\$.50}{0.04} = \$37.50The current price of the stock is 37.50.Underthefirstalternativebusinessstrategy,thepriceofthestockwoulddecreaseto37.50. Under the first alternative business strategy, the price of the stock would decrease to 30.00. Under the second alternative business strategy, the price of the stock would remain the same at $37.50.

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