Question

Assume​ Evco, Inc. has a current stock price of $ 52.98 $52.98 and will pay a $ 2.10 $2.10 dividend in one​ year; its equity cost of capital is 12 % 12%. What price must you expect Evco stock to sell for immediately after the firm pays the dividend in one year to justify its current​ price?

Answer 1

Ans:- As per Gordon Model Current Stock Price (P0) is calculated by D1 / (ke - g)  where D1 is the next dividend to be paid, P0 is the current stock price. ke is the cost of equity and g is the growth rate. and D1 = D0*(1+g), where g is the growth rate.

First, we need to find the growth rate

P0 = D1 / (ke - g)

ke -g = D1 / P0

or ke - ( D1 / P0) = g.

Note:- Stock Price in 1 year is calculated by D0*(1+g) / (ke - g) [ Since D1 for this year becomes D0 for the next year to calculate the next years stock Price ]

Therefore the price in 1 year for the stock will be $57.24.(approx).

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