Omni Telecom is trying to decide whether to increase its cash dividend immediate
ID: 2541846 • Letter: O
Question
Omni Telecom is trying to decide whether to increase its cash dividend immediately or use the funds to increase its future growth rate.
P0 = D1 Ke g P0 = Price of the stock today
D1 = Dividend at the end of the first year
D1 = D0 × (1 + g) D0 = Dividend today
Ke = Required rate of return
g = Constant growth rate in dividends
D0 is currently $3.50, Ke is 9 percent, and g is 5 percent.
Under Plan A, D0 would be immediately increased to $4.00 and Ke and g will remain unchanged.
Under Plan B, D0 will remain at $3.50 but g will go up to 6 percent and Ke will remain unchanged.
a. Compute P0 (price of the stock today) under Plan A. Note D1 will be equal to D0 × (1 + g) or $4.00 (1.05). Ke will equal 9 percent, and g will equal 5 percent. (Round your intermediate calculations and final answer to 2 decimal places.)
b. Compute P0 (price of the stock today) under Plan B. Note D1 will be equal to D0 × (1 + g) or $3.50 (1.06). Ke will be equal to 9 percent, and g will be equal to 6 percent. (Round your intermediate calculations and final answer to 2 decimal places.)
Explanation / Answer
A. Compute P0 (Price of the stock today) under Plan A
Data’s Given,
D0 = $ 4.00
Ke = 9 %
G = 5 %
PO = D0 (1+g) / (Ke – g)
= $ 4.00 (1.05) / (0.09 – 0.05)
= $ 4.20 / 0.04
P0 = $ 105/Share
B. Compute P0 (Price of the stock today) under Plan B
Data’s Given,
D0 = 3.50
Ke = 9 %
G = 6 %
PO = D0 (1+g) / (Ke – g)
= $ 3.50 (1.06) / (0.09 – 0.06)
= $ 3.71 / 0.03
P0 = $ 123.67/Share
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