Question

Market is expecting 14 per cent return from the ordinary share of a company. Investors are expecting $0.90 dividend per share from this company in next year. It is also predicted that the dividend for this company will grow at a constant rate of 6 per cent forever. What current price is expected for this ordinary share?

Answer 1

Solution:

As per the Gordon growth Model, the current price of a share is calculated using the following formula:

P₀ = D₁ / ( k_e – g )

Where

P₀ = Current Price of the share;      D₁ = Dividend per share payable next year = Next Dividend ;

g = growth rate of dividend ;   k_e = Expected return ;

As per the information given in the question we have ;

D₁ = $ 0.90 ;   g = 6 % = 0.06 ;   k_e = 14.00 % = 0.14     ;

Applying the above values in the formula we have the current price of share as

= 0.90 / ( 0.14 – 0.06 )

= 0.90 / 0.08

= $ 11.25

Thus the current price expected for this ordinary share = $ 11.25