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Radio Shack has 1 million shares outstanding with market value of $20 million. The firm is expected to pay $1

million in dividends next year and thereafter the amount paid out is expected to grow by 5% per year in perpetuity. Thus the expected dividend is $1.05 million in year 2, $1.105 million in year 3 and so on. However, the company has heard that the value of a share depends on the flow of dividends and announces that next year’s dividend will be increased to $2 million and that the extra cash to pay the dividend will be raised immediately by a secondary equity offering. After that, the total amount paid out each year will be as previously forecasted ($1.05 million in year 2 and increasing by 5% in each subsequent year).

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