Competing design agency as part of growth strategy

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Reference no: EM13937679

Wombat+Wombat is a well-established creative design agency located on the East Coast. It has experienced very stable growth in both earnings and dividends over the past 10 years, averaging 7% per annum. Dividends are typically paid at the end of each year, the most recent dividend of $3.00 per share having just been paid to shareholders.

Wombat+Wombat is considering the acquisition of a competing design agency as part of its growth strategy. The firm would need to issue new shares of common stock in order to finance this acquisition. However, the acquisition itself will result in changes to the dividends the firm is expected to pay to common stockholders. Specifically, the firm will need to suspend dividend payments for a period of time in favour of reinvesting earnings back into growth projects associated with the acquisition. Dividends are expected to resume in three years time, at which point the firm will pay a dividend of $5.00 per share. This dividend is subsequently expected to grow at 20% per annum for two years, at 15% per annum for the following two years, and then at 8% per annum thereafter. This growth strategy will cause investors to revise their required returns upwards to 20% per annum. What price would investors be willing to pay for new shares of common stock issued by Wombat+Wombat to finance the acquisition?

Reference no: EM13937679

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