Problem 11-09

The dividend-growth model,

suggests that an increase in the dividend growth rate will increase the value of a stock. However, an increase in the growth may require an increase in retained earnings and a reduction in the current dividend. Thus, management may be faced with a dilemma: current dividends versus future growth. As of now, investors required return is 14 percent. The current dividend is $0.9 a share and is expected to grow annually by 4 percent, so the current market price of the stock is $9.36. Management may make an investment that will increase the firms growth rate to 6 percent, but the investment will require an increase in retained earnings, so the firms dividend must be cut to $0.4 a share. Should management make the investment and reduce the dividend? Round your answer to the nearest cent.

The value of the stock (rises or declines)to $___________ so the management (should no or tshould) make the investment and decrease the dividend.