Question

Sid Glasses recently paid a dividend of $1.70 per share, is currently expected to grow at a constant rate of 5% and has a required return of 11%. Sid Glasses has been approached to buy a new company. Sid estimates if it buys the company, its constant growth rate would increase to 6.5%, but the firm would also be riskier, therefore increasing the required return of the company to 12%. Should Sid go ahead with the purchase of the new company

Answer 1

Sid should buy the company

Step-by-step explanation:

given data

dividend = $1.70 per share

constant rate = 5%

required return = 11%

growth rate increase = 6.5%

increasing the required return = 12%

solution

we get here intrinsic value of the company in both by use Gordon Growth Model that is here present value

PV = ( Do × (1 + g) ) ÷ (r - g) .......................1

here Do is current dividend and g is growth rate and r is required rate of return

so here put value in current case

PV = ( 1.7 × (1 + 0.05) ) ÷ (0.11 - 0.05)

solve it we get

PV = $29.75 .............................2

and

now put value for buying company case

so

PV = ( 1.7 × ( 1 + 0.065)) ÷ ( 0.12 - 0.065)

solve it we get

PV = $32.92 ..............................3

so Sid should go ahead buying the company