Scotto Manufacturing is a mature firm in the machine tool component industry. The firm’s most recent common stock dividend was $2.40 per share. Because of its maturity as well as its stable sales and earnings, the firm’s management feels that dividends will remain at the current level for the foreseeable future.
a) If the required return is 12%, what will be the value of Scotto’s common stock?
b) If the firm’s risk as perceived by market participants suddenly increases, causing the required return to rise to 20%, what will be the common stock value?
c) Judging on the basis of your findings in parts (a) and (b), what impact does risk have on value?