Rakesh Ltd., has just paid a dividend of ₹32 per share. On account of modernisation (heavy investment in automated technologies) of plant, the directors intend not to pay any dividend for the next two years' period. Howe

Situation I (Present Situation - No Modernisation): Given: D 0 (Dividend just paid) = ₹32 g (Growth rate) = 8% = 0.08 K e (Cost of equity) = 18% = 0.18 The share price (P 0 ) using the Gordon Growth Model is: P 0 = D 0 * (1 + g) / (K e - g) P 0 = ₹32 * (1 + 0.08) / (0.18 - 0.08) P 0 = ₹32 * 1.08 / 0.10 P 0 = ₹34.56 / 0.10 P 0 = ₹345.60 Situation II (Proposed Situation - With Modernisation): Given: No dividend for Year 1 and Year 2. Dividend at the end of Year 3 (D 3 ) = ₹24 g (Growth rate from Year 3 onwards) = 14% = 0.14 K e (Cost of equity) = 18% = 0.18 First, calculate the share price at the end of Year 2 (P 2 ), just before the dividend stream starts growing consistently: P 2 = D 3 / (K e - g) P 2 = ₹24 / (0.18 - 0.14) P 2 = ₹24 / 0.04 P 2 = ₹600 Now, discount this future price back to the present (Year 0) to find the current share price: P 0 = P 2 / (1 + K e ) 2 P 0 = ₹600 / (1 + 0.18) 2 P 0 = ₹600 / (1.18) 2 P 0 = ₹600 / 1.3924 P 0 = ₹430.90 (approximately) Advice to the Board of Directors: Comparing the share values in both situations: Situation I (No Modernisation): ₹345.60 Situation II (With Modernisation): ₹430.90 Since the share price in the proposed situation (with modernisation) is higher (₹430.90) than in the present situation (without modernisation) (₹345.60), the Board of Directors should adopt the modernisation processes. This decision is expected to enhance shareholder wealth.