Question

# The Jackson Company has just paid a dividend of \$3.00 per share on its common stock,...

The Jackson Company has just paid a dividend of \$3.00 per share on its common stock, and it expects this dividend to grow by 10 percent per year, indefinitely. The firm has a beta of 1.50; the risk-free rate is 10 percent; and the expected return on the market is 14 percent. The firm's investment bankers believe that new issues of common stock would have a flotation cost equal to 5 percent of the current market price. How much should an investor be willing to pay for this stock today?

As per the Dividend Discount Model, the price of the stock is calculated by using the following formula

The Current Price of the Stock = D0(1 + g) / (ke – g)

Required Rate of Return (Ke)

As per CAPM Model, Required Rate of Return (Ke) = Rf + Beta(Rm – Rf)

= 10% + 1.50(14% - 10%)

= 10% + 6%

= 16%

Where, Last Year Dividend (D0) = \$3.00 per share

Required Rate of return (Ke) = 16%

Dividend growth rate (g) = 10%

The Current Price of the Stock = D0(1 + g) / (ke – g)

= \$3.00(1 + 0.10) / (0.16 – 0.10)

= \$3.30 / 0.06

= \$55.00 per share

“Therefore, the investor be willing to pay \$55.00 per share for this stock today”