Early in 2007, Inez Marcus, the chief financial officer for Suarez Manufacturing, ws given the task of assessing the impact of a proposed risky investment on the firm's stock value. To perform the necessary analysis, Inez gathered the following information on the firm's stock.
During the immediate past 5 years (2002 - 2006), the annual dividends paid on the firm's common stock were as follows:
Year Dividend per share
2006 $1.90
2005 $1.70
2004 $1.55
2003 $1.40
2002 $1.30
The firm expects that without the proposed investment, the dividend in 2007 will be $2.09 per share and the historical annual rate of growth (rounded to the nearest whole percent) will continue in the future. Currently, the required return on the common stock is 14%. Inez's research indicates that if the proposed investment is undertaken, the 2007 dividend will rise to $2.15 per share and the annual rate of dividend growth will increase to 13%. She feels that in the best case, the dividend would continue to grow at this rate each year into the future and that in the worst case, the 13% annual rate of growth in dividends would continue only through 2009, and then, at the beginning of 2010, would return to the rate that was experienced between 2002, and 2006. As a result of the increased risk associated with the proposed risky investment, the required return on the common stock is expected to increase by 2% to an annual rate of 16%, regardless of which dividend growth outcome occurs.
Armed with the preceding information, Inez must now assess the impact of the proposed risky investment on the market value of Suarez's stock. To simplify her calculations, she plans to round the historical trowht rate in common stock dividends to the nearest whole percent.
a. Find the current value per share of Suarez Manufacturing's common stock.
B. Find the value of Suarez's common stock in the event that it undertakes the proposed risky investment and assuming that the dividend growth rate stays at 13% forever. Compare this value to that found in part a. What effect would the proposed inveestment have on the firm's stockholders? Explain.
C. On the basis of your findings in part b, do the stockholders win or lose as a result of undertaking the proposed risky investment? Should the firm do it? Why?
D. Rework part b and c assuming that at the beginning of 2010 the annual dividend growth rate returns to the rate experienced between 2002 and 2006.
I know it's a long question, but I need help. Ok. for problem a, I know that formula for price of a share is:
Dividend / required return - growth rate.
So when it's asking for current value, which is 2007, it would be
$2.09 / 0.14 - .158
Then, I get a negative number.
Did I get the growth rate right?
$2.09 - $1.30 / 5
Help plz...
Well, it seems like you made a small mistake in your calculation for the growth rate. Let me help you with that.
To find the growth rate, you need to divide the difference in dividends over the 5-year period by the number of years. In this case, it would be:
($2.09 - $1.30) / 5 = $0.39 / 5 = $0.078
So the growth rate would be approximately 7.8% (rounded to the nearest whole percent).
Now let's calculate the current value per share:
Dividend / (Required return - growth rate)
$2.09 / (0.14 - 0.078) = $2.09 / 0.062 ≈ $33.71
So the current value per share of Suarez Manufacturing's common stock is approximately $33.71.
Now that we have the correct value, we can move on to the next parts of the question.
To find the current value per share of Suarez Manufacturing's common stock, you need to use the Dividend Discount Model (DDM) formula:
Current Value per Share = Dividend / (Required Return - Growth Rate)
However, you have made a mistake in calculating the growth rate. To calculate the historical growth rate, you need to use the formula:
Growth Rate = (Dividend in 2006 - Dividend in 2002) / Dividend in 2002
Let's calculate the correct value step-by-step:
Step 1: Calculate the growth rate
Growth Rate = ($1.90 - $1.30) / $1.30
Growth Rate = $0.60 / $1.30
Growth Rate = 0.4615
Growth Rate ≈ 46.15%
Step 2: Calculate the current value per share
Current Value per Share = $2.09 / (0.14 - 0.4615)
Current Value per Share = $2.09 / (0.14 - 0.4615)
Current Value per Share ≈ $2.09 / -0.3215
Current Value per Share ≈ -$6.477
It seems that you have made an error in calculating the growth rate, which resulted in a negative current value per share. Double-check your calculations and make sure to include the correct values for dividends and dates.
To calculate the current value per share of Suarez Manufacturing's common stock, you need to use the formula:
Current Value per Share = Dividend / (Required Return - Growth Rate)
In this case, the dividend for 2007 is $2.09 per share, the required return is 14%, and the growth rate is the historical annual rate of growth rounded to the nearest whole percent.
To calculate the growth rate, you need to find the average growth rate over the past 5 years. You do this by subtracting the initial dividend in 2002 ($1.30) from the final dividend in 2007 ($2.09), and then dividing by the number of years (5) to get the annual growth rate.
($2.09 - $1.30) / 5 = $0.79 / 5 = $0.158
Rounding to the nearest whole percent, the growth rate is 16%.
Now you can calculate the current value per share:
Current Value per Share = $2.09 / (0.14 - 0.16) = $2.09 / (-0.02)
When you divide by a negative number, you get a negative result. This means the current value per share cannot be calculated using the given numbers. You might want to go back and check if there are any errors in the provided information or if you have missed any details.
Regarding your calculation of the growth rate, you did not calculate it correctly. The growth rate should be calculated as the difference between the final and initial dividends divided by the initial dividend:
($2.09 - $1.30) / $1.30 = $0.79 / $1.30
Make sure to double-check your calculations and use the correct values for the dividend, required return, and growth rate in the formula to calculate the current value per share.