Use the information for the question(s)below.
The JRN Corporation will pay a constant dividend of $3 per share,per year,in perpetuity.Assume that all investors pay a 20% tax on dividends and that there is no capital gains tax.The cost of capital for investing in JRN stock is 12%.
-Assume that management makes a surprise announcement that JRN will no longer pay dividends but will use the cash to repurchase stock instead.The price of a share of JRN's stock is now closest to:
A)$20.00.
B)$25.00.
C)$18.00.
D)$24.00.

Question

Quizplus · Accepted Answer

The current price of JRN's stock can be calculated using the formula for the constant dividend growth model:

P0 = D / (r - g)

Where:
P0 = current price of stock
D = dividend per share
r = cost of capital
g = growth rate of dividends

Since JRN will no longer pay dividends and instead repurchase stock, the growth rate of dividends (g) will be 0. Therefore, the new price of JRN's stock can be calculated as follows:

P0 = 3 / (0.12 - 0) = $25.00

Therefore, the best choice is B, with a new price of $25.00 per share.

Use the Information for the Question(s)below