Question

JRN Enterprises just announced that it plans to cut its​ next-year dividend, D1​, from $2.50 to $1.30 per share and use the extra funds to expand its operations. Prior to this​ announcement, JRN's dividends were expected to grow at 3​% per year and​ JRN's stock was trading at $24.00 per share. With the new​ expansion, JRN's dividends are expected to grow at 6​% per year indefinitely. Assuming that​ JRN's risk is unchanged by the​ expansion, the value of a share of JRN after the announcement is closest​ to:

Answer 1

Given about JRN Enterprises,

They are planning to cut its​ next-year dividend, D1​, from $2.50 to $1.30 per share and use the extra funds to expand its operations

So, prior to dividend cut,

Price = $24

Dividend growth rate g = 3%

So, expected rate of return R is calculated using constant dividend growth rate:

Expected return R = g + D1/P0 = 0.03 + 2.5/24 = 13.42%

After dividend cut, Expected dividend D1 = $1.3

dividend growth rate g = 6%

Since risk is still the same, expected return is same

So, price of the stock after announcement P0 = D1/(r-g) = 1.3/(0.1342 - 0.06) = $17.53

the value of a share of JRN after the announcement is closest​ to $17.53