Mercier Corporation Solution ***I am going to assume you know all the Finance Ja
ID: 2687182 • Letter: M
Question
Mercier CorporationExplanation / Answer
***I am going to assume you know all the Finance Jargons + Formula Mercier Corporation’s stock is selling for $95. It has just paid a dividend of $5 a share. The expected growth rate in dividends is 8 percent. a. What is the required rate of return on this stock Using DDM, 95 = 5*(1+0.08) / (r - 0.08) ---> r = 13.68% b. Using your answer to (a), suppose Mercier announces developments that should lead to dividend increases of 10 percent annually. What will be the new value of Mercier’s stock? Using DDM again, 5*(1+0.1) / (13.68% - 10%) = $149.46 c. Again using your answer to (a), suppose developments occur that leave investors expecting that dividends will not change from their current levels in the foreseeable future. Now what will be the value of Mercier stock? Using DDM again, 5*(1+0)/(.1368-0) = $36.55 d. From your answers to (b) and (c), how important are investors’ expectation of future dividend growth to the current stock price? Very important as the future dividend growth rate affects price very much. However, in reality, it is important to know DDM model is not a very good estimate true stock price especially for growth stocks (those may not issue dividend or consistently)