Question

Stock Price impacts During the immediately preceding 4 years, the annual dividend paid on the firm’s common stock has grown from $3.91 to $4.58 (Do), or by approximately a dollar, which equates to a 4% growth rate. Andrew Potts believes that without the proposed investment, the historical annual dividend growth rate will continue into the future. Currently the required rate of return on the common stock is 13%. Andres Potts’ research indicates that if the proposed inventory investment is undertaken, the annual rate of dividend growth will rise to 7% and the coming year’s dividend will rise to $4.90 per share. He feels that in the best case, the dividend would continue to grow at this rate each year forever into the future. Or, essentially, that he would replace this inventory project with a similar project repeatedly in the future. In the anticipated case, the 7% annual rate of dividend growth would continue for only two years, and then at the beginning of the third year the dividend growth rate would return to the 4% rate that was experienced over the past four years. In the worst case, the firm’s growth rate will drop to zero, due to the use of valuable managerial resources managing inventory assignment across Garcia Energy and the losses incurred if the economy were to deteriorate in a world where it had amassed extra inventory. As a result of the increased risk associated with the proposed risky investment, the required rate of return on the common stock is expected to increase by 1% to an annual rate of 14%. This required rate of return applies regardless of which dividend growth outcome occurs. Armed with the preceding information, Andrews has tasked you with assessing the impact of the proposed risky investment on the market value of Garcia Energy’s stock. In this scenario analysis, your examination has shown that the best case scenario is likely to happen 20 percent of the time, anticipated case 70 percent of the time, and worst case 10 percent of the time. Note on grading: Up to two points will be awarded in each of the scenarios (i.e., 1. Best case, 2. Anticipated case, and 3. Worst case) listed below. You can earn 1.5 points for the proper inputs and 1.5 points for the correct price estimate, Po. Obviously, correct prices have the correct inputs, however you should report the inputs (D1, D2, D3, rs, g) in computing Po to earn partial credit in instances wherein you have not computed the correct share price. All of these inputs are not required in all situations.

3. Worst case. Recalculate the current price assuming that project is undertaken and the growth rate drops to zero.

4. In between 200 and 300 words summarize the above information in Part II.B and provide Andrew Potts with an analysis of his upcoming inventory decision from the perspective of its impact on the current stock price. (3 points)

Answer 1

Dividend discount model should be used to calculate with formula mentioned in excel.

we are also using time value of money concepts.