In mid-December 2001, Jim Vala has another meeting with Bill Jones.

During the meeting, Jones says:

As you know, Jones Group has recently divested DCom. At the time of that transaction, we signed a 20-year lease that gives DCom access to our pipeline property. We have just been informed that, as a result of current market conditions, DCom will default on the lease payment. We need that cash to service the debt that was retained by Jones Group at the time of the divestiture.

Jones continues:

We should consider a new dividend policy to conserve cash. Dividends per share will total $1.65 in 2001. I think we should reduce our dividend by 40 percent and maintain that lower level for 2002 and 2003 to allow us to pay off some debt. In 2004, we will increase our dividend back to $1.65, then growth the dividend at 5 percent annually thereafter.

The required rate of return on Jones Group equity is 10 percent for the foreseeable future.

Calculate, using a dividend discount model (DDM) approach, the expected share price of Jones Group equity on January 1, 2002, given the new dividend policy described by Jones. Show your calculations.

Dividend Practice Question

Beth Knight, CFA, and David Royal, CFA, are independently analyzing the value of Bishop, Inc. stock. Bishop paid a dividend of $1 last year. Knight expects the dividend to grow by 10% in each of the next 3 years after which it will grow at a constant rate of 4% per year. Royal expects a temporary growth rate of 10% followed by a constant growth rate of 6.15%, but he expects the supernormal growth to last for only 2 years. Knight estimates that the RR on Bishop stock is 9%, but Royal believes the RR is 10%. Royals valuation of Bishop stock is approximately:

A. equal to Knights valuation

B. $5 less than Knights valuation

C. $5 more than Knights valuation