Question

Cooperton Mining just announced it will cut its dividend from $4.13 to $2.48 per share and use the extra funds to expand. Prior to the​ announcement, Cooperton's dividends were expected to grow at a 3.3% ​rate, and its share price was $50.09. With the planned​ expansion, Cooperton's dividends are expected to grow at a 4.5% rate. What share price would you expect after the​ announcement? (Assume that the new expansion does not change​ Cooperton's risk.) Is the expansion a good​ investment?

Answer 1

Step-1, Calculation of the Required Rate of Return (KE) using the Dividend Growth Model

Dividend per share (D1) = $4.13 per share

Current Dividend Growth Rate (g) = 3.30% per year

Current Share Price (P0) = $50.09 per share

Required Rate of Return (KE) using the Dividend Growth Model = [D1 / P0] + g

= [$4.13 / $50.09] + 0.0330

= 0.0825 + 0.0330

= 0.1155 or

= 11.55%

Step-2, Calculation of the share price after the​ announcement

Revised Dividend per share (D1) = $2.48 per share

Revised Dividend Growth Rate (g) = 4.50% per year

Required Rate of Return (KE) = 11.55%

As per the Dividend Discount Model, Share Price = D1 / (Ke – g)

= $2.48 / (0.1155 - 0.0450)

= $2.48 / 0.0705

= $35.18 per share

“Therefore, the share price after the announcement would be $35.18 per share”

DECISION

“NO”. This expansion not a good​ investment for the Cooperton Mining, since after the announcement, the share price is dropped from $50.09 per share to $35.18 per share.