Management action and stock value   REH​ Corporation's most recent dividend was $ 1.94

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 7
​%
and lower the required return to 13
​%.
c.  Eliminate an unprofitable product​ line, which will increase the dividend growth rate to 8
​%
and raise the required return to 17 %
.
d.  Merge with another​ firm, which will reduce the growth rate to 1
​%
and raise the required return to 18
​%.
e. Acquire a subsidiary operation from another manufacturer. The acquisition should increase the dividend growth rate to  9 %

and increase the required return to 17
​%.
Question content area bottom
Part 1
a.  If the firm does nothing that will leave the key financial variables​ unchanged, the value of the firm will be ​$enter your response here
.
​(Round to the nearest​ cent.)

To calculate the value of the firm's stock under each scenario, we will use the **Dividend Discount Model (DDM)** for a constantly growing dividend. The formula is given as:

\[
P_0 = \frac{D_1}{r - g}
\]

Where:
- $ P_0 $ is the stock price.
- $ D_1 $ is the expected dividend in the next year (calculated as $ D_0 \times (1 + g) $, where $ D_0 $ is the most recent dividend).
- $ r $ is the required rate of return.
- $ g $ is the expected growth rate of dividends.

### Part 1: 
#### a. Do nothing (unchanged financial variables)

- **Most recent dividend** $ D_0 = 1.94 $
- **Dividend growth rate** $ g = 5\% = 0.05 $
- **Required return** $ r = 15\% = 0.15 $

First, calculate the expected dividend $ D_1 $:

\[
D_1 = D_0 \times (1 + g) = 1.94 \times (1 + 0.05) = 1.94 \times 1.05 = 2.037
\]

Now, apply the DDM formula to calculate the stock price:

\[
P_0 = \frac{2.037}{0.15 - 0.05} = \frac{2.037}{0.10} = 20.37
\]

So, the value of the firm if no changes are made is **$20.37**.

---

Let me know if you'd like me to continue with the remaining parts, or if you have any questions. 

Here are 5 follow-up questions for further analysis:

1. How does a change in the growth rate affect stock valuation?
2. Why does the required return have an inverse effect on stock price?
3. Can we use this model for companies with no dividend payments?
4. How would a changing dividend policy impact investor perception?
5. What role does risk play in determining the required rate of return?

**Tip:** Always verify the inputs like growth rates and required returns as small variations can lead to significant changes in valuation!

Management action and stock value   REH​ Corporation's most recent dividend was $1.94 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 7% and lower the required return to 13%.
 c.  Eliminate an unprofitable product​ line, which will increase the dividend growth rate to 8% and raise the required return to 17%.
 d.  Merge with another​ firm, which will reduce the growth rate to 1% and raise the required return to 18%.
 e. Acquire a subsidiary operation from another manufacturer. The acquisition should increase the dividend growth rate to  9% and increase the required return to 17%.

Learn how to calculate the stock price of REH Corporation using the Dividend Discount Model (DDM) with different scenarios. Explore the effects of varying dividend growth rates and required returns on stock value. This example uses real data, including a dividend of $1.94 per share, a growth rate of 5%, and a required return of 15%. Ideal for finance students and professionals.

Math Problem Statement

Solution

Ask a new question for Free

By Image

Math Problem Analysis

Mathematical Concepts

Formulas

Theorems

Suitable Grade Level

Related Recommendation