Question

The next dividend for the Marx Company will be $4 per share. Investors require a 16 percent return on companies such as Marx. Marx’s dividend increases at a constant rate of 6 percent every year.

a) What is the value of Marx’s stock today?

b) What is the value of Marx’s stock in four years?

Answer 1

a. Value of stock today :

Using Gordon model, price of stock = Dividend in year 1/(Expected return - growth rate) = 4/(0.16 - 0.06) = $ 40.

b. Value of stock in 4 years

We will use the 2 stage Gordon model for this. We need to find the dividend for each year and discount it at the Expected return.

Dividend in year 1 = 4*1.06 = 4.24

Dividend in year 2 = 4*(1.06^2) = 4.4944

Dividend in year 3 = 4*(1.06^3) = 4.7640

Dividend in year 4 = 4*(1.06^4) =5.0499

We will discount the dividend values using the discount rate of 16%.

Price of stock =(4.24/1.16)+(4.4944/1.16^2)+(4.7640/1.16^3)+(5.0499/1.16^4)+((5.0499*1.06) (1.06)/(0.16-0.06))/1.16^4 = 44.17