Question

Management action and stock value   REH​ Corporation's most recent dividend was $1.72 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 6​% and raise the required return to 18%.

d.  Merge with another​ firm, which will reduce the growth rate to 3​% 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 18​%.

Answer 1

REH Corporation's Stock Value will be calculated using the dividend discount model.

Value of the stock = Dividend at Time 0 * (1 + Growth Rate) / (required return - growth rate)

= 1.72 * (1.05) / (0.15-0.05)

= 1.806/0.10

= $18.06 This is the value of the REH Corporation's stock.

Proposal A:

As the situation will be unchanged: the value of the stock will be $18.06

Proposal B: Growth rate increases to 6% and required return decreases to 14%

= 1.72 * 1.06 / (0.14-0.06)

= 1.8232/0.08

= 22.79 is the value of the stock if proposal B is accepted

Proposal C: Dividend growth rate is 6% and required return increases to 18%

= 1.72 * 1.06/ 0.18-0.06

= 1.8232/0.12

= 15.19 is the value of the stock if proposal C is accepted

Proposal D: Dividend growth rate is 3%, required rate of return 18%

= 1.72*1.03/0.18-0.03

= 1.7716/0.15

= 11.8106 is the value of the stock if proposal D is accepted

Proposal E: Dividend growth rate is 9%, and required rate of return is 18%

= 1.72*1.09/0.18-0.09

= 1.8748/0.09

= 20.8311 is the value of the stock if proposal E is acepted