Solar Inc. pays a current dividend of $2.50 per share annually. This dividend is

Question

Solar Inc. pays a current dividend of $2.50 per share annually. This dividend is expected to grow at the rate of 3.25% per year for the foreseeable future. Rating LLC has given Solar Inc. a beta score of 1.05.The risk-free rate of return is currently 1.25% and is expected to remain therefore some time. The current market rate of return is 5.625%.

Answer the following questions:

a. What price would you expect Solar Incorporated’s stock to sell?

b. If the risk-free rate of return increases to 3.5% and the market rate of return changes to 7.875%, what impact will that have on the expected price of Solar Inc.’s stock

c. Solar Inc. is anticipating a significant merger and acquisition to enhance their productivity and reduce their fixed costs. As a result of this acquisition, management expects their beta to drop to 0.95.Their dividend growth rate is expected to increase to 4% and remain there indefinitely. Assuming that all other conditions used in “a” remain the same, would you recommend this acquisition to the board of directors?

Explanation / Answer

a)

Required rate of return for equity = risk-free rate + (market risk premium × beta for equity)

= 1.25 + (4.375*1.05)

= 5.84375

Price = D1/(k-g)

Where:
D1 = dividend for the coming year}
k = required rate of return; k must be}
greater than g
g = growth rate of dividends

= 2.5(3.25%)/(5.84375 - 3.25)

=$99.518 per share

b)

k = 3.5 + (4.375*1.05) = 8.09375%

Price = 2.5(3.25%)/(8.09375-3.25) = $53.29 per share

c)

k = 1.25 + (4.375*0.95) = 5.40625%

Price = 2.5(4%)/(5.40625 - 4) = $184.89 per share

I would recommend these acquisition since price of the share increases to $184.89

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

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