EBK CFIN
EBK CFIN
6th Edition
ISBN: 9781337671743
Author: BESLEY
Publisher: CENGAGE LEARNING - CONSIGNMENT
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Chapter 7, Problem 11PROB
Summary Introduction

The company will pay a dividend of $0.50 at the end of 2 years which is then expected to grow at a rate of 6%. Required rate of return on the stock is 14%.

Gordon constant growth model is used to determine the value of a stock. The model assumes that the dividend paid by the company would continue to grow at a constant rate in the foreseeable future. The present value of all these dividends paid till perpetuity is the market or present value of the stock. The model also assumes that the required rate of return of the stock should always be greater than the growth rate, otherwise, the value would become negative and meaningless.

Value of the stock when the dividends are growing at a constant rate is

P0=D1rsg=D0(1+g)rsgwhere,D1=dividend paid next yearD0=dividend paid this yearrs=required rate of returng=growth rate of dividend in perpetuity

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Dividend disocunt model (DDM); Author: Edspira;https://www.youtube.com/watch?v=TlH3_iOHX3s;License: Standard YouTube License, CC-BY