Question
Blue Diamond, Inc., a manufacturer of glass screens just paid an annual dividend of $11.82. Analysts are predicting a 5% per year growth rate in
Blue Diamond, Inc., a manufacturer of glass screens just paid an annual dividend of $11.82. Analysts are predicting a 5% per year growth rate in dividends forever. If Blue Diamond just announced that it unexpectedly lost an intellectural property lawsuit and was required to pay a penalty. The penalty is $184 million to be paid at the end of this year and $56million to be paid at the end of next year.
a. If Blue Diamond's equity cost of capital is 13.6%, what price should Blue Diamond's stock be?
b. If Blue Diamond has 37 million shares outstanding and the equity cost of capital remains at 13.6% after losing the lawsuit, what change in Blue Diamond's stock price would you expect upon this announcement? (Assume that the value of Blue Diamond's debt is not affected by the event.)
c. Would you expect to be able to sell Blue Diamond's stock on hearing this announcement and make a profit? Explain.
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