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 ?
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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