Part II. Stock Price Impacts
During the preceding four years, the annual dividend paid on the firm's common stock has grown
from $3.78 to $4.60 (Do), or a little over a dollar, equating to approximately a five percent (5%) growth
rate. Carlos Ruiz believes that the historical annual dividend growth rate will continue without a
proposed investment. Currently, the required rate of return on the common stock is 13%, and the stock
price is $60.38.
Carlos Ruiz's research indicates that the annual dividend growth rate will rise if a proposed
expansion is undertaken. In the best case, he feels that the dividend would continue to grow at this rate
each year and will continue to do so forever into the future. Essentially, he would replace this expansion
project with a similar project repeatedly in the future. In the anticipated case, the higher annual dividend
growth rate would continue for only two years, and then, at the beginning of the third year, the dividend
growth rate would fall back to a more normal level. In the worst case, the firm's growth rate would drop
over time due to the use of valuable managerial resources managing inventory assignment across and the
losses incurred if the economy were to deteriorate in a world where it had amassed extra inventory. As a
result of the increased risk associated with the proposed risky investment, the required return on the
common stock is expected to grow by 1% to an annual rate of 14%. This required rate of return applies
regardless of which dividend growth outcome occurs.
Armed with the preceding information, Carlos has tasked you with assessing the impact of the proposed
risky investment on the market value of RAVI's stock. In this scenario analysis, your examination has
shown that the best case scenario is likely to happen 20 percent of the time, the anticipated case 65
percent of the time, and the worst case 15 percent of the time. {Note on grading: Correct prices have the
correct inputs, so you should report the inputs (D1, D2, D3, ts, g) in computing Po. Reporting of inputs also
allows you to earn partial credit in instances wherein you have not computed the correct share price.}
So far, you have computed the Best case value of $100.28, assuming the dividend will grow to $5.014, a
required return of 14 required rate of return, and a 9 percent growth rate expected to last forever in the
Best-case scenario. The resulting equation is ($4.60 x 1.09)/ (0.14-0.09). You still need to compute the
pricing in the Anticipated-case and Worst-case scenarios.
1. Anticipated case. Estimate RAVI's price under the Anticipated scenario, which is two years of above-
normal 8 percent growth and then returning to the long-run average of 5 percent growth. (5 points)
2. Worst case. Recalculate the current price assuming that the project is undertaken and that costs exceed
revenues after the initial customers are satiated in addition to the required return rising. Hence, the
growth rate for the overall company is only 6 percent for one year, falls back to 5 percent in Year 2,
and then drops to 2 percent from that point onward. (6 points)
3. In the Executive Summary, summarize your findings. Discuss the gain or loss in value in the
Anticipated-case and Worst-case scenarios. Include a weighted average of the expected stock price
(i.e., Summation of probability times price in a given outcome) relative to the current stock price. (3
points)
