Question

The share of a certain stock paid a dividend of Rs. 2 last year. The dividend is expected to grow at a constant rate of 7 percent in the future. The required rate of return on this stock is considered to be 14 %. How much should this stock sell for now assuming that the expected growth rate and required rate of return remain the same. At what price should the stock sell 4 years hence ?

Answer #1

The price of the Stock can be calculated by using the
**Gordon Growth
Model**

The formula for calculating the stock price is

**P = D1 / ( r - g )**

where P = Price of the Stock

D1 = Dividend expected in the next year

r = required rate of return

g = constant dividend growth rate

**A) Stock price
now**

D1 = 2 * 1.07 = 2.14

r = 14% = 0.14

g = 7% = 0.07

P = 2.14 / ( 0.14 - 0.07 )

= 2.14 / 0.07

= **$
30.57**

**Therefore the expect stock price now as per Gordon
Growth Model is $ 30.57**

**B) Stock price
4 years from now**

D5 = 2 * (1.07^5)

= 2 * 1.4025

= 2.805

r = 14% = 0.14

g = 7% = 0.07

P = D5 / ( r - g )

P = 2.80 / (0.14 - 0.07 )

= 2.805 / 0.07

= **$
40.07**

**Therefore the expect stock price 4 years from now as per
Gordon Growth Model is $ 40.07**

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