RN Enterprises just announced that it plans to cut its dividend from $2.00 to $1

Question

RN Enterprises just announced that it plans to cut its dividend from $2.00 to $1.20 per share and use the extra funds to expand its operations. Prior to this announcement, JR's dividends were expected to grow at 3% per year and JRN's stock was trading at $26.00 per share. With the new expansion RN's dividends are expected to grow at 6% per year indefritely. Assuming that JRN's nsk is unchanged by the expansion, the value of a share ofJRN after the announcement is closest to: O A. $25.58 B. S26.00 ? C. $42.63 OD. $15.60

Explanation / Answer

Step – 1, Firstly calculate the Cost of Equity Prior to the announcement

Cost of Equity [Ke] = [ D1 / P0 ] + g

= [$2.00 / $26.00 ] + 0.03

= 0.0769 + 0.03

= 0.1069

= 10.69%

Step -2 ,Compute the Value of the share after the announcement

P0 = D1 / [ Ke – g ]

= $1.20 / [ 0.1069 – 0.06 ]

= $1.20 / 0.0469

= $25.58

Hence, The Answer is “ A. $25.58 “

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