Question

Green gadgets inc. is trying to decide whether to cut its expected divident for next year from $10 per share to $7 per share in order to have more money to invest in new projects. If it does not cut the dividend, Green Gadgets expected rate of growth in dividends is 5% per year and the price of their common stock will be $105 per share. However, if it cuts its dividend, the dividend growth rate is expected to rise to 8% in the future. Assuming that the investor's required rate of return for Green Gadgets' stock does not change, what would you expect to happen to the price of its common stock it is cuts the dividend to $7? Should Green Gadgets cut its divident? Support your answer as best you can.

A. What is the investor's required rate of return for Green Gadgets' stock? ________% (round to two decimal paces)
B. Assuming that the investor's required rate of return for Green Gadget's stock does not change, what would you expect to happen to the price of its common stock if it cuts dividend to $7? $_______ (round to the nearest cent)
C. Should Green Gadgeds cut its dividend? ( select from the drop down menus)
Green Gadgets Should / Should not cut the dividend because cutting the dividend will increase / decrease the value of the common stock.

Answer 1

The price of Green Gadgets Inc.'s common stock after cutting the dividend to $7 can be estimated using the Gordon Growth Model by considering the required rate of return and new dividend growth rate. The decision to cut the dividend should weigh the short-term and long-term financial implications and the potential growth from new investments.

Step-by-step explanation:

When Green Gadgets Inc. is considering whether to cut its expected dividend from $10 to $7 per share, it is important to assess the potential impact on the stock price and whether the dividend cut aligns with the best interests of the shareholders. Using the Gordon Growth Model (also known as the Dividend Discount Model), we can estimate the price of the common stock based on the future dividends and growth rate.

The investor's required rate of return should equal the yield implied by the current price of $105 per share with a $10 dividend growing at 5%. If we assume that the required rate of return does not change, cutting the dividend to $7 with an 8% growth rate would require recalculating the stock price with the new dividend and growth rate.

To determine if Green Gadgets should cut the dividend, we must consider both the short-term and long-term financial implications, including how the retained earnings will be used, potential growth due to new investments, and the overall investor sentiment. Without exact figures, it's impossible to provide a definitive answer on the stock price after the cut; however, if the new projects are successful and increase the company's value, the stock price may eventually rise despite the initial negative impact from a dividend cut.