Consider a firm that had been priced using a 10.5 percent growth rate and a 12.5

Question

Consider a firm that had been priced using a 10.5 percent growth rate and a 12.5 percent required return. The firm recently paid a $1.55 dividend. The firm has just announced that because of a new joint venture, it will likely grow at an 11.0 percent rate.

How much should the stock price change (in dollars and percentage)? (Do not round intermediate calculations and round your final answers to 2 decimal places.)

Consider a firm that had been priced using a 10.5 percent growth rate and a 12.5 percent required return. The firm recently paid a $1.55 dividend. The firm has just announced that because of a new joint venture, it will likely grow at an 11.0 percent rate.

Explanation / Answer

Current Pricing

As per dividend discount model, Stock price is gievn by the following:

Stock Price = D1 / (Re - G)

Where,

D1 = Expected dividend next year = Current dividend + Growth in dividend = $1.55 + $1.55 x 10.5%

= $1.71275

Re = Required rate of return = 12.5%

G = Growth rate of the stock = 10.5%

So, Price = $1.71275 / (0.1250 - 0.1050)

= $85.6375

New Price

As per dividend discount model, Stock price is gievn by the following:

Stock Price = D1 / (Re - G)

Where,

D1 = Expected dividend next year = Current dividend + Growth in dividend = $1.55 + $1.55 x 11%

= $1.7205

Re = Required rate of return = 12.5%

G = Growth rate of the stock = 11%

So, Price = $1.7205 / (0.1250 - 0.11)

= $114.7

So, Change in stock price = $114.7 - $85.6375 = $29.06

and Percentage change in price = Change in price / Original Price

= $29.06 / $85.6375

= 33.93%

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