10

Summit Systems has an equity cost of capital of

10.0 %, will pay a dividend of $1.00 in oneyear, and its dividends had

Been expected to grow by 6.5 %

per year. You read in the paper that Summit Systems has revised its growth prospects and now expects its dividends to grow at a rate of 3.5 %

per year forever.

a. What is the drop in value of a share of Summit Systems stock based on thisinformation?

b. If you tried to sell your Summit Systems stock after reading thisnews, what price would you be likely toget? Why?

a. What is the drop in value of a share of Summit Systems stock based on thisinformation?

The drop in value of a share of Summit Systems stock is

$. (Round to the nearestcent.)

1. If you tried to sell your Summit Systems stock after reading thisnews, what price would you be likely to get?

The price of a share would likely be

$. (Round to the nearest cent.)

Why? (Select the best choice below.)

A.

You would receive $ 28.57 because when you bought thestock, the dividend growth rate was still

6.5 %

.

B.

You would receive $ 28.57 if you act very quickly because it takes a day or two for markets to incorporate the information about the new growth rate.

C.

You would receive $ 15.38 because markets are efficient and would incorporate the information about the new growth rate immediately.

D.

You would receive a price between $ 15.38 and $ 28.57 because you should get a blend of the old and new growth rate of dividends.