About bond calculation?

Question

Michael Jackson, the new CFO of Cool-Dance is considering increasing the company’s
growth rate by entering a new line of business. Currently, Cool-Dance has a current
dividend of $4.5 per share and its dividend is expected to grow at a constant rate of 5%.
The company’s required rate of return is 15%. Michael Jackson has estimated that if
Cool-Dance enters this new line of business the growth rate in dividends and earnings
will increase to a constant rate of 9% per year, but the required rate of return also
increases to 20%. Should Michael Jackson enter this new line of business?

Answer 1

That's not a bond calculation, it's a dividend discount model question. The general form of the DDM is that the intrinsic value of the company is the value of the next expected dividend divided by the required return - the growth rate. So to solve the question just compare intrinsic values. Like so:

Current Situation:
Next expected dividend: 4.5 *1.05 = 4.73
Intrinsic Value: 4.73/(.15-.05) = $47.25

New Business:
Next expected dividend: 4.5*1.09 = 4.91
Intrinsic Value: 4.91/(.2-.09) = $44.59

So the new business actually decreases the intrinsic value of the firm and should not be pursued.