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Eastern Telecom - Dividend valuation model and wealth maximization

Eastern Telecom is trying to decide whether to increase its cash dividend immediately or use the funds to increase its future growth rate. It will use the dividend valuation model originally presented in Chapter 10 for purposes of The model was shown as Formula 10-9 and is reproduced below (with a slight addition in definition of terms).
analysis.

D0 is currently $3.00, Ke is 10 percent, and g is 5 percent.

Under Plan A, D0 would be immediately increased to $3.40 and Ke and g will remain unchanged.

Under Plan B, D0 will remain at $3.00 but g will go up to 6 percent and Ke will remain unchanged.

a. Compute P0 (price of the stock today) under Plan A. Note D1 will be equal to D0 × (1 + g) or $3.40 (1.05). Ke will equal 10 percent and g will equal 5 percent.

b. Compute P0 (price of the stock today) under Plan B. Note D1 will be equal to D0 × (1 + g) or $3.00 (1.06). Ke will be equal to 10 percent and g will be equal to 6 percent.

c. Which plan will produce the higher value?

Solution Preview

Eastern Telecom is trying to decide whether to increase its cash dividend immediately or use the funds to increase its future growth rate. It will use the dividend valuation model originally presented in Chapter 10 for purposes of The model was shown as Formula 10-9 and is reproduced below (with a slight addition in definition of terms). ...

Solution Summary

This solution is comprised of a detailed explanation to compute P0 (price of the stock today) under Plan A (Note D1 will be equal to D0 × (1 + g) or $3.40 (1.05) and Ke will equal 10 percent and g will equal 5 percent, compute P0 (price of the stock today) under Plan B (Note D1 will be equal to D0 × (1 + g) or $3.00 (1.06) and Ke will be equal to 10 percent and g will be equal to 6 percent) and answer which plan will produce the higher value.

$2.19