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FIN 423: HOMEWORK ASSIGNMENT Date given: 10-APR-2011 Date Due: The Day of the Final Exam Early in 2007, Guna, the Chief financial Officer for Suresh...

Early in 2007
FIN 423: HOMEWORK ASSIGNMENT Date given: 10-APR-2011 Date Due: The Day of the Final Exam Early in 2007, Guna, the Chief financial Officer for Suresh 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, Guna gathered the following information on the firm’s stock. During the immediate past 5 years (2002 – 2006), the annual dividends paid on the firm’s common stock were as follows: Year Dividend per share 2006 Tk.1.9 2005 1.70 2004 1.55 2003 1.40 2002 1.30 The firm expects that without the proposed investment, the dividend in 2007 will be Tk. 2.09 per share and the historical rate of growth (rounded to the nearest whole percent) will continue in the future. Currently the required return on the common stock is 14 percent. Guna’s research indicates that if the proposed investment is undertaken, the 2007 dividend will rise to Tk. 2.15 per share and the annual growth rate will increase to 13 percent. She feels that in the best case , the dividend would continue to grow at this rate each rate into the future and in the worst case, 13 percent annual growth rate of dividend would continue only through 2009, and then, at the beginning of 2010, would return to return to the rate that was experienced between 2002 and 2006. 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 percent to an annual rate of 16 percent, regardless of which dividend growth outcome occurs. Armed with the preceding information, Guna must now assess the impact of the proposed risky investment on the market value of Shuresh’s stock. To simplify her calculations, she plans to round the historical growth rate in common stock dividends to the nearest whole percent. TO DO a. Find the current value per share of Suresh Manufacturing’s common stock. b. Find the value of Suresh’s common stock in the event that it undertakes the proposed risky investment and assuming that the dividend growth rate stays at 13 percent 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 stock holders win or lose as result of undertaking the proposed risky investment? Should the firm do it? Why? d. Rework parts b and c assuming that the beginning of 2010 the annual dividend growth rate returns to the rate experienced between 2002 and 2006.
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