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on the firm’s stock value. To perform the necessary analysis, Inez gathered the following information on the firm’s stock.
During the immediate past 5 years (1999–2003), the annual dividends paid
on the firm’s common stock were as follows:
Year Dividend per share 2003 $1.90 2002 1.70 2001 1.55 2000 1.40 1999 1.30 The firm expects that without the proposed investment, the dividend in 2004
will be $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%. Inez’s research indicates that if the proposed CHAPTER 7 Stock Valuation 349 investment is undertaken, the 2004 dividend will rise to $2.15 per share and the
annual rate of dividend growth will increase to 13%. She feels that in 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 2006, and then, at the beginning of 2007, would return
to the rate that was experienced between 1999 and 2003. 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, Inez must now assess the impact of
the proposed risky investment on the market value of Suarez’s stock. To simplify
her calculations, she 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 Suarez Manufacturing’s common stock.
b. Find the value of Suarez’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
d. Rework parts b and c assuming that at the beginning of 2007 the annual dividend growth rate returns to the rate experienced between 1999 and 2003. WEB EXERCISE
W To use the price/earnings multiples approach to valuation, you need to find a
firm’s projected earnings and the P/E multiple. One of the most popular sites to
obtain these estimates is Zacks Investment Research, www.zacks.com.
1. At the top of the page, locate the area where you can enter a company’s
ticker symbol and select the desired information.
2. Enter OO for Oakley Inc. and select estimates from the pull-down menu.
a. What is the current mean/consensus estimate for the next fiscal year’s
b. Using the indicated price/earnings ratio further down on that page, calculate the stock price.
3. Repeat steps 2a and b for the following stocks:
a. Southwest Airl...
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