Question

REH Corporation's most recent dividend was $2.11 per share, is expected annual rate of dividend growth is 5%, and the required return is now 15%. A variety of proposals are being considered by management to redirect the firm's activities, Determine the impact on share price for each of the following proposed actions.

a. Do nothing, which will leave the key financial variables unchanged b. Invest in a new machine that will increase the dividend growth rate to 6% and lower the required return to 12%
b. Eliminate an unprofitable product line, which will increase the dividend growth rate to 7% and raise the required retum to 16%
c. Invest in a new machine that will increase the dividend growth rate to 6% and lower the required return to 12%
d. Merge with another firm, which will reduce the growth rate to 4% and raise the required return to 10%
e. Acquire a subsidiary operation from another manufacturer. The acquisition should increase the dividend growth rate to 99% and increase the required

Answer 1

The share price of REH Corporation can be calculated using the Gordon Growth Model. The share price changes based on management's actions, such as investing in a new machine or merging with another firm, which affect the growth rate and required return.

Step-by-step explanation:

To determine the impact on share price of REH Corporation following various proposed actions, we can use the Gordon Growth Model, which calculates the present value of an infinite series of future dividends that are expected to grow at a constant rate. The formula is P = D / (r - g), where P is the price, D is the most recent dividend, r is the required return, and g is the growth rate.

• Do nothing: The current dividend is $2.11, growth rate is 5%, and required return is 15%. The price would be P = $2.11 / (0.15 - 0.05) = $2.11 / 0.10 = $21.10.
• Invest in new machine: This would lead to a growth rate of 6% and a required return of 12%. The price would be P = $2.11 / (0.12 - 0.06) = $2.11 / 0.06 = $35.17.
• Eliminate unprofitable line: This action would lead to a growth rate of 7% and a required return of 16%. The price would be P = $2.11 / (0.16 - 0.07) = $2.11 / 0.09 = $23.44.
• Merge with another firm: This would reduce the growth rate to 4% and raise the required return to 10%. The price would be P = $2.11 / (0.10 - 0.04) = $2.11 / 0.06 = $35.17.
• The scenario with a 99% dividend growth rate is unrealistic and would imply an infinite share price, which is not feasible.