HigherEducation, Inc., a private educational company\'s share price is $130 per
ID: 2653815 • Letter: H
Question
HigherEducation, Inc., a private educational company's share price is $130 per share; earnings and dividends are $12.20 a share, and the growth rate is zero. They have just announced a new growth strategy whereby the company's earnings would begin growing by 6% per year and remain stable at this new rate. This new growth strategy will require the company to reinvest 40% of their earnings starting at the end of this year (t = 1). What will happen to the price per share of this company? Think carefully, and draw a time line.
a)Insufficient information to determine the price change.
b)Price will remain unchanged.
c)Price will decrease by $86.27 per share.
d)Price will increase by $86.27 per share.
Explanation / Answer
When there is no growth
Cost of Equity = Dividend/Current Share Price
Cost of Equity = 12.20/130
Cost of Equity = 9.3846%
Share Price after changes = Expected Dividend/Cost of Equity - growth rate)
Share Price after changes = (12.20*(1-40%))/(9.3846%-6%)
Share Price after changes = $ 216.27
Price will increase by = 216.27 - 130
Price will increase by =$ 86.27
Answer
d)Price will increase by $86.27 per share