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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