The Board of Directors of Hennessey Corp. are assessing the impact of their plan

Question

The Board of Directors of Hennessey Corp. are assessing the impact of their plans on the price of their common stock and their shareholders’ value. Presently, the firm’s dividends have been growing at a sustained 16% annual rate. The firm’s required rate of return is 17% and the Board’s planned next dividend is $2.10 (annualized).

The company is presented with a series of opportunities that will require additional funding. One alternative being considered is to raise this funding by increasing retained earnings and slowing the growth of the dividends to 15%. Changing the growth rate will not change the required return (17%) or the next dividend ($2.10).

Many directors assert the small (1%) change in dividend growth rate (with no reduction in dividends) will have a negligible impact on shareholder value and want to proceed immediately. You have been asked to evaluate the decision.

a. Determine the present Hennessey stock price.
b. Determine the stock price if the alternative is pursued.
c. Should the firm pursue this course of action? Why / Why not?

Explanation / Answer

(a)   Determining the Present Hennessey Stock Price:

Dividend growth rate (g) = 16%

Required Rate of Return = 17%

Expected Dividend for next year (D1) = $2.10

Calculating Stock Price:

Hennessey Stock Price (P0) = [D1 / (R – g)]

Hennessey Stock Price (P0) = [$2.10 / (0.17 – 0.16)]

Hennessey Stock Price (P0) = [$2.10 / 0.01]

Hennessey Stock Price (P0) = $210

(b)   Determining the Stock Price if the alternative is pursued:

One alternative being considered is to raise this funding by increasing retained earnings and slowing the growth of the dividends to 15%.   Changing the growth rate will not change the required return (17%) or the next dividend ($2.10).

Dividend growth rate (g) = 15%

Required Rate of Return = 17%

Expected Dividend for next year (D1) = $2.10

Calculating Stock Price:

Hennessey Stock Price (P0) = [D1 / (R – g)]

Hennessey Stock Price (P0) = [$2.10 / (0.17 – 0.15)]

Hennessey Stock Price (P0) = [$2.10 / 0.02]

Hennessey Stock Price (P0) = $105

(c)    No, the firm should not pursue this change. Why because increasing retained earnings will be cause for declining growth rate of dividend. This will results decreasing stock price to $105 of Hennessey.

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.