Question

Please add the explanation.

6. Killnum Corp. announces that the dividend for the next year will be $2.50 per share rather than the originally expected $1.50 per share. From then on, it is expected that dividends will resume their historical constant growth rate of 5% per year. What would you expect to happen to the price of the stock? Ignore any tax effects.

A) The price will likely double.

B) The price will likely rise by less than 100%.

C) The price will likely rise by exactly 50%.

D) The price will remain unchanged.

E) The price will likely rise by the present value of $1.

Answer 1

According to the given information

Expected DIvidend = $ 1.50 per share

Actual Dividend = $ 2.50 per share

Increased dividend = 2.50 - 1.50

= $ 1 per share

Percentage increase in dividend per share = Increased Dividend / Expected Dividend

= 1 / 1.50

= 0.6667 or 66.67%

So, the dividend has increased by 66.67%.

Now we should know that the stock price will increase at the rate with which the dividend per share increases.

We will evaluate the options as follows

Option A: The price will likely double.

As there is 66.67% increase in dividend per share, so the price of the share cannot be double after the increased dividend.

Option B: The price will likely rise by less than 100%

This is the correct asnwer as the price increase at the rate of dividend increase of 66.67% and the increase is less than 100%.

Option C: The price will likely rise by exactly 50%

This is uncorrect as increase in dividend is more than 50% that is 66.67%. So price will also rise by more than 50%.

Option D: The price will remain unchanged.

This is uncorrect as with increase in dividend paid the share price also increases.

Option E: The price will likely rise by the present value of $1

This is uncorrect as the effect of increase is 66.67%. So the value of the share will increase according to the actual price of share.

Therefore the correct answer is option (B)

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