Question

Dubai Metro's stock price was at $100 per share when it announced that it will cut its dividend for next year from $6 per share to $2 per share, with additional funds used for expansion. Prior to the dividend cut, Dubai Metro expected its dividends to grow at a 7 percent rate, but with the expansion, dividends are now expected to grow at 10 percent. How do you think the announcement will affect Dubai Metro's stock price? What is the investor's required rate of return for Dubai Metro's stock? 13.00*% (Round to two decimal places.) What would be the price of Dubai Metro's stock if they cut the dividend to $2? $ 66.6f (Round to the nearest cent.) How do you think Dubai Metro's stock price will react to the announcement? (Select from the drop-down menu.) If Dubai Metro were to cut the dividend, the price of the common stock will decrease.

Answer 1

The stock price of Dubai Metro is expected to decrease initially due to the dividend cut from $6 to $2. The required rate of return is 13.00%, and the stock price after the cut is expected to be $66.67. However, the expected growth rate increase from 7% to 10% could offset the negative impact over time.

Step-by-step explanation:

The announcement by Dubai Metro to cut its dividend from $6 to $2 per share, with the intention of using the additional funds for expansion, is expected to initially affect the stock price negatively. Investors typically value the current income from dividends; therefore, a cut in the dividend can make a stock less attractive, causing the stock price to decrease. However, if the market believes that the expansion will lead to higher future growth, it may eventually lead to a positive revaluation of the stock. As the company expects dividends to grow at a 10 percent rate post-expansion, higher than the previous 7 percent, this suggests confidence in future profitability and could offset the initial negative impact of the dividend cut.

The investor's required rate of return for Dubai Metro's stock is 13.00%. Using the Gordon Growth Model (P = D1 / (k - g)), where P is the price, D1 is the expected dividend next year, k is the required rate of return, and g is the growth rate, we can calculate the expected stock price after the dividend cut to be: P = $2 / (0.13 - 0.10) = $66.67, after rounding to the nearest cent. This suggests a significant drop from the current price of $100, due to the reduced dividend.

Answer 2

Dubai Metro's announcement to cut dividends for expansion might lead to an initial decrease in stock price, similar to trends observed in other companies. If the dividend is cut to $2, the expected new stock price would be $66.67, assuming a 13% required rate of return and a 10% growth rate.

Step-by-step explanation:

When a company like Dubai Metro announces a reduction in dividends, this can initially lead to a decrease in the stock price. Investors often see dividends as a sign of a company's profitability and financial health, and a cut might lead to concerns about the company's current performance. However, the decision to use these funds for expansion could indicate a focus on long-term growth, which might eventually lead to higher returns for investors.

Using the Gordon Growth Model, the initial stock price can be calculated using the expected dividend and the growth rate. The expected stock price after the dividend cut with the investor's required rate of return at 13% and a growth rate of 10% would result in:

Price = Dividend / (Required Rate of Return - Growth Rate)
Price = $2 / (0.13 - 0.10)
Price = $2 / 0.03
Price = $66.67

The new expected stock price is $66.67, which shows a decrease from the original price of $100. This demonstrates how sensitive stock prices can be to changes in dividend policy and growth expectations. It's also important to consider that stock prices can fluctuate greatly due to a variety of factors, such as market trends and investor sentiment, as seen with companies like Netflix and Face-book in the past.