Question $4$

A$.$ Red Corporation's most recent dividend was $$3$ per share; its expected annual rate of dividend growth is

$5\%,$ and the required return is now $15\%.$ Management is considering a variety of proposals to redirect

the firm's activities. Determine the impact on share price for each of the following proposed actions and

indicate the best alternative to maximize shareholders' wealth and why.

$(2$ Marks$)$

i$.$ Invest in a new machine that will increase the dividend growth rate to $6\%$ and lower the required

return to $14\%.$

ii$.$ Eliminate an unprofitable product line, which will increase the dividend growth rate to $7\%$ and

raise the required return to $17\%.$

B$.$ Briefly explain at least two reasons why you would consider using the $\frac{P}{E}$ multiples approach over the

dividend growth model in common stock valuation.

$(2$ Marks$)$