Question

Assessing the Impact of Suarez? Manufacturing's Proposed Risky Investment on Its Stock Value???Early in? 2013, Inez? Marcus, the chief financial officer for Suarez? Manufacturing, was 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? (2008-2012), the annual dividends paid on the? firm's common stock were as? follows:

Year	Dividend per share
2012	$1.90
2011	$1.70
2010	$1.55
2009	$1.40
2008	$1.30

The firm expects that without the proposed? investment, the dividend in 2013 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 14.0%. ?Inez's research indicates that if the proposed investment is?undertaken, the 2013 dividend will rise to $2.15 per share and the annual rate of dividend growth will increase to 13.0%. 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 13.0% annual rate of growth in dividends would continue only through? 2015, and? then, at the beginning of? 2016, would return to the rate that was experienced between 2008 and 2012. 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 2.0% to an annual rate of 16.0%?, 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 Do

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 13.0%

forever. Compare this value to that found in part ?(a?). What effect would the proposed investment 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 parts ?(a?) and ?(b?) assuming that at the beginning of 2016 the annual dividend growth rate returns to the rate experienced between 2008 and 2012

Answer 1

a)
First solved for growth rate (g) using the geometric growth equation
g = ( $1.90/$1.30)^1/4 - 1 =	9.95%
Growth rate g =	10.00%	approx
Use the constant growth rate model
Current value per share = D1 /(r-g)
D1 = $1.90 x (1+10%)	$2.09
Required Return	14.00%
Current value per share = $2.09/(14%-10%)	$52.25
b)
Growth rate	13.00%	forever
Required Return	16.00%
Value of share = $1.90 x (1+13%)/(16%-13%)	$71.57
The higher growth rate increases the market value of the stock
c)
The firm should undertake the proposed project. The price per share increases by $19.32 (from $52.25 to $71.67) though increased in required return increases the risk but it can be offset by higher dividend growth resulting in a net increase in value.
d)
Year	Period	Dividend = d1 x(1+13%)^n	PV @ 16%	Present Value
2013 (given)	1	$2.15	0.862068966	$1.85
2014	2	$2.43	0.743162901	$1.81
2015	3	$2.75	0.640657674	$1.76
Terminal Value @ 2016 = ($2.75 x 1.10) /(16% -10%)	3	$50.42	0.640657674	$32.3
Value of Share				$37.72
The firm should not undertake the proposed project. The price per share de creases by $14.53 (from $52.25 to $37.72) though increased in required return increases the risk but it cannot be offset the increase in cash flows resulting in net decrease in value.