VALUATION OF A CONSTANT GROWTH STOCK
Investors require a 17% rate of return on Levine Company's stock (i.e., r_{s} = 17%).
What is its value if the previous dividend was D_{0} = $2.50 and investors expect dividends to grow at a constant annual rate of (1) -4%, (2) 0%, (3) 5%, or (4) 11%? Do not round intermediate calculations. Round your answers to two decimal places.
(1) $
(2) $
(3) $
(4) $
a. The value of the stock (P0)=D1/(r-g)
1. If growth rate,g=-4%
D1=D0*(1+g%)=2.50*(1-4%)=$2.4
P0=$2.4/(17%-(-4%))=$11.43
2. If growth rate=0%
D1=D0=$2.5
P0=2.5/(17%-0%)=$14.70
3. If growth rate=5%
D1=2.5*(1+5%)=2.625
P0=2.625/(17%-5%)=$21.88
4. if growth rate=11%
D1=2.5*(1+11%)=2.775
P0=2.775/(17%-11%)=$46.25
b. If growth rate is equal to or greater than required rate of return, the denominator will either become zero or negative which is fundamentally wrong in Grodon growth model
==>D1/(15%-15%)
==>D1/(15%-20%)
So,option V is correct
These results show that the formula does not make sense if the required rate of return is equal to or less than the expected growth rate.
c. 1. Option IV is correct.
If not reasonable for a firm to grow indefenitely (g>r). Companies sometimes face supernatural growth, in thoses cases its fine for a shorter period of time
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