Required a. Find the current value per share of Sneaker Manufacturing’s common stock. b. Find the value of Sneaker’s common stock in the event that it undertakes the proposed risky investment and assuming that the dividend growth rate stays at 13% forever. Compare this value to that found in part a. What effect would the proposed investment have on the firm’s stockholders? Explain. c. On the basis of your findings in part b, do the stockholders win or lose as a result of undertaking the proposed risky investment? Should the firm do it? Why?
Early in 2020, Mr. Karim, the chief financial officer for Sneaker Manufacturing, was given the task of assessing the impact of a proposed risky investment on the firm’s stock value. To perform the necessary analysis, Mr. Karim gathered the following information on the firm’s stock. During the immediate past 5 years (2015–2019), the annual dividends paid on the firm’s
common stock were as follows:
Year Dividend per share
2019 Tk. 1.90
2018 1.70
2017 1.55
2016 1.40
2015 1.30
The firm expects that without the proposed investment, the dividend in 2020 will be Tk. 2.09 per
share and the historical annual rate of growth (rounded to the nearest whole percent) will
continue in the future. Currently, the required return on the common stock is 14%. Karim’s
research indicates that if the proposed investment is undertaken, the 2020 dividend will rise to
Tk. 2.15 per share and the annual
the best case, the dividend would continue to grow at this rate each year into the future and
that in the worst case, the 13% annual rate of growth in dividends would continue only through
2022, and then, at the beginning of 2023, would return to the rate that was experienced between 2015 and 2019. As a result of the increased risk associated with the proposed risky investment, the required return on the common stock is expected to increase by 2% to an annual rate of 16%, regardless of which dividend growth outcome occurs.
Armed with the preceding information, Karim must now assess the impact of the proposed risky investment on the market value of Sneaker’s stock. To simplify his calculations, he plans to round the historical growth rate in common stock dividends to the nearest whole percent.
Required
a. Find the current value per share of Sneaker Manufacturing’s common stock.
b. Find the value of Sneaker’s common stock in the event that it undertakes the proposed risky investment and assuming that the dividend growth rate stays at 13% forever. Compare this value to that found in part a. What effect would the proposed investment have on the firm’s
stockholders? Explain.
c. On the basis of your findings in part b, do the stockholders win or lose as a result of undertaking the proposed risky investment? Should the firm do it? Why?
d. Rework parts b and c assuming that at the beginning of 2023 the annual dividend growth rate returns to the rate experienced between 2015 and 2019.
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