During the immediately preceding 4 years, the annual dividend paid on the Garcia Energys common stock has grown from $3.91 to $4.58 (Do), or by approximately a dollar, which equates to a 4% growth rate. Andrew Potts believes that without a proposed investment, the historical annual dividend growth rate will continue into the future. Currently the required rate of return on the common stock is 13%.

Andrew Potts research indicates that if the proposed expansion is undertaken, the annual rate of dividend growth will rise to 7% and the coming years dividend will rise to $4.90 per share. He feels that in the best case, the dividend would continue to grow at this rate each year forever into the future. Or, essentially, that he would replace this expansion project with a similar project repeatedly in the future. In the anticipated case, the 8% annual rate of dividend growth would continue for only two years, and then at the beginning of the third year the dividend growth rate would return to the 4% rate that was experienced over the past four years. In the worst case, the firms growth rate rise by 8% for one year and then drops to 2% percent, due to the use of valuable managerial resources managing inventory assignment across Garcia Energy and the losses incurred if the economy were to deteriorate in a world where it had amassed extra inventory.

As a result of the increased risk associated with the proposed risky investment, the required rate of return on the common stock is expected to increase by 1% to an annual rate of 14%. This required rate of return applies regardless of which dividend growth outcome occurs. Armed with the preceding information, Andrews has tasked you with assessing the impact of the proposed risky investment on the market value of Garcia Energys stock. In this scenario analysis, your examination has shown that the best case scenario is likely to happen 20 percent of the time, anticipated case 70 percent of the time, and worst case 10 percent of the time.

Note on grading: Correct prices have the correct inputs, so you should report the inputs (D₁, D₂, D3, r_s, g) in computing P_o. Reporting inputs also allows you to earn partial credit in instances wherein you have not computed the correct share price.

1 Current stock price. Compute Garcia Energys current stock price. (4 points)

2 Best case. Find the value of Garcia Energys common stock in the event that it undertakes the proposed investment and the subsequent dividend growth rate stays at 7% forever. (4 points)

3. Anticipated case. Recalculate the current price assuming that after two years the average annual dividend growth rate returns from 7% to 4%. (6 points)

4. Worst case. Recalculate the current price assuming that project is undertaken and the growth is only half of what is expected in the anticipated case scenario. (6 points)

5. In between 200 and 300 words summarize the above information in Part III and provide Andrew Potts with an analysis of his upcoming inventory decision from the perspective of its impact on the current stock price, discussing each estimated share price. (4 points)

6. Executive Summary: In 100 words, discuss the overall implications of this key management decision (2 points)