Question

A company last paid a dividend of £3. If the expected return on its equity is estimated at 12% and its shares are currently quoted on London Stock Exchange at £75, what should the dividend growth rate be to ensure that the price is consistent with the pricing of a growing perpetuity?

Answer 1

Answer - growth rate = 7.6923%

Concept of Dividend discount model

As per dividend discount model price of the share is equal to the present value of all the future dividends discounted using expected return on equite

S0 = D1 / (Re - g)

S0 = Stock price today = 75

Re = return on equity = 0.12

g = growth rate of dividend

D1 = Dividend at the end of year 1

D1 = 3 * (1+g)

Solution

Putting values in the above formulae

75 = 3*(1+g) / (0.12-g)

75 (0.12-g) = 3 + 3g

9 - 75g = 3 + 3g

78g = 6

g = 6 / 78

g = 0.0769 ot 7.69%

answered by: anonymous