Lotte Group is planing on diversifying into the transportation industry. As a result, Lotte's beta would rise to 1.3 from 1.1 and the expected long-term growth rate in the firm's earnings would increase from 11% to 14%. Currently the risk-free rate is 5.0% and the market risk premium is 8.6%. If Lotte's current dividend is $1.30, should Lotte diversify into the transportation industry?
A) No, stock price does not increase
B) No, stock price declines about $10.11
C) Yes, stock price increases about $19.42
D) Yes, stock price increases by about $26.27

Question

Quizplus · Accepted Answer

Solution: k_old = 0.05 + 1.1(0.086) = 0.1446 P₀ = $1.30(1.11) / (0.1446 - 0.11) = $41.71 k_new = 0.05 + 1.3(0.086) = 0.1618 P_new = $1.30(1.14) / (0.1618 - 0.14) = $67.98

Lotte Group Is Planing on Diversifying into the Transportation Industry