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    Stocks: Dividend Discount Model

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    How do I go about the mathematical part to this question?

    The fund you represent is a significant shareholder in IM Industries which just paid a dividend of $5.25 per share and is currently expected to grow in perpetuity at 5% each year. Management has proposed a significant re-structuring of the business which will cost a lot of capital, only part of which can be raised externally. They are proposing that the board of directors suspend dividend payments for 2 years to finance the re-organization after which (in year 3), dividends of $5.00 per share will be re-instated. The re-organization will also cost the firm $100 million in the first year, and $80 million in year 2. This re-organization however will enable dividends to grow at 7% a year from that point forward in perpetuity.

    If the appropriate discount rate is 11% under either alternative and the firm has 40,000,000 shares outstanding, should you vote to support the re-organization or not?

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    Solution Preview

    We should calculate the value per share under the two alternatives:

    1. The current situation - using the dividend discount model
    Value per share = D1/(Required return - growth rate)
    D0 = current dividend = 5.25
    required return = 11%
    growth ...

    Solution Summary

    This solution provides steps necessary to determine whether one should vote to support the re-organization of IM Industries or not.

    $2.19

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