Applying the Dividend-Discount Model (E-I11)

Exercise E-I11.

Okay um this exercise is about how to apply the the dividend discount model um so we have some information in the exercise text okay and i want want to to write these down so info the first information we get is that the furniture house just announced it will cut its dividend from uh 3.82 1.25 per share and use the extra fund to expand okay expand they want

To like change the the company uh like to get more money within the company so they can use that money to to actually uh yeah make the company bigger prior to the announcement furniture houses dividends were expected to grow 3.2 percent rate and its share price was 35.12 with the new expansion furnitures houses dividends are expected to grow 5. i expected to

Grow at a 5.4 percent rate okay so what we got out of that was that they are changing the system so we haven’t before and then after uh before the dividend was a 3.18 and after they will only pay out 1.25 however the growth rate will increase from 3.2 percent to a 5.4 percent which is interesting because we we want to find the best solution like should

What will happen with the stock price after the announcement and we are in a we are in a all the assumptions like all all the all our results are based on that we are in the strong form of the of an efficient market where all information is public and and uh so so every uh so the the stock will the stock will change immediately after an announcement and we know

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From the dividend discount bottle where with a constant dividend growth model like the constant dividend growth model we have the price which is equal to the dividend year one like the yeah divided by the the expected return to equity like what what the equity holders expects to earn from from this stock so what we need is the respected because we have like the

Price of the stock before the announcement share price was 35.12 so we have one we have the price of the stock the the growth rate and the dividend uh yeah but the the the dividend of of the of of per share sorry for for my brain not being so good there uh yeah so we can just rearrange this formula so that’s and how how do would we do that we’ll just i’ll just

Do the algebra so you understand the process uh that would be dividends divided by the price a plus because then this is alone and then we just need to plus the g then we get the expected return to equity or to the shareholders and then we just find our excel sheet i’ve just illustrated the formulas here or the sorry the information from the text is the

Same text a and we just do as we just did a group in in the algor we have we had the dividends the dividends divided by the price of the share which is plus the plastic growth which is 12 point 25 percent uh yeah so the return the expected return to the shareholders would be 12.25 percent then we know what they expect then we can calculate if this is


A good idea or not and we have the the numbers we can just continue using the the formula from here with the after the and nouns announcement and then just plug the the information in because after the announcement we know that the dividend would is going to be 1.25 and and the expected return is not is not going to change because they are still expecting uh

12.25 and if they get more the the value of the firm will just increase but will it increase with this new uh with with this new way where the the furniture house is trying to make the investors or the shareholders more money by like keeping some of the the case in-house and if we calculate that finds that the price after the announcement um so we had we

Had the dividend the new dividend the new dividend payout to return on equity and the growth rate the new divided by this this and it’s because it’s in excel so you need to like make these around the yeah and then you see that the stock is going to fall by a lot actually um and we find that price will fall to which is actually quite a lot let’s make a six

Here so instead of uh 35.12 the stock price will fall to 18 point two three six is is the expansion a positive investment no it’s obviously not because there is the same amount of share outstanding we have no information about that so the the price the npv the effect of of them the value it creates or actually takes out of the the company by by this new by

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By these new changes would be oh with this obviously to have before and after which is oh no no no after we need to have need to find what is going on after uh compared to before so this would be uh the npv would actually fall by 15 whoops it’s obviously a minus oops messing around and i’m making the same mistake it should be this the price before no

The price what did i just write if after after the changes uh minus after this is after like that six minus 16. so so what share price would you expect after the announcement okay in a efficient market where all public information is available and the the reaction is instantly uh the share price would drop to 18 point two three six units we don’t know oh

It’s us dollars which will decrease the the value of the firm by by 16.884 per share in in present value which so is the expansion a positive npv no because uh yeah i hope that helped you

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Applying the Dividend-Discount Model (E-I11) By P2P Finance 101