Problem 11-09

The dividend-growth model,

suggests that an increase in the dividend growth rate will increase the value of a stock.

However, an increase in the growth may require an increase in retained earnings and a reduction in the current dividend.

Thus, management may be faced with a dilemma: current dividends versus future growth.

As of now, investors required return is 13 percent.

The current dividend is $1.3 a share and is expected to grow annually by 5 percent, so the current market price of the stock is $17.06.

Management may make an investment that will increase the firms growth rate to 7 percent, but the investment will require an increase in retained earnings, so the firms dividend must be cut to $1.2 a share.

Should management make the investment and reduce the dividend?

Round your answer to the nearest cent.

The value of the stock -Select-(rises or declines) to $ , so the management -Select- (should or not should) make the investment and decrease the dividend.