Mpumalanga Corporation's shares recently paid a dividend of R2.00 per share (D0 = R2), and the share is in equilibrium.The company has a constant growth rate of 5 percent and a beta equal to 1.5.The required rate of return on the market is 15 percent, and the risk-free rate is 7 percent.Mpumalanga is considering a change in policy which will increase its beta coefficient to 1.75.If market conditions remain unchanged, what new constant growth rate will cause the ordinary share price of Mpumalanga to remain unchanged?

Question

Quizplus · Accepted Answer

Using the constant growth model, we can find the current share price of Mpumalanga Corporation:

P0 = D0(1+g) / (r-g)
P0 = 2(1+0.05) / (0.15-0.05)
P0 = R22

Next, we can use the capital asset pricing model (CAPM) to find Mpumalanga's required rate of return with the new beta:

r = Rf + beta(Rm - Rf)
r = 0.07 + 1.75(0.15-0.07)
r = 0.22 or 22%

Now we can again use the constant growth model to find the new constant growth rate that will keep the share price unchanged:

P0 = D1 / (r-g)
R22 = 2.00(1+g) / (0.22-g)
g = 6.77%

Therefore, Mpumalanga's constant growth rate would need to increase to 6.77% with the new beta coefficient in order to maintain its current share price.

Mpumalanga Corporation's Shares Recently Paid a Dividend of R2