Question

Company ABC recently paid a yearly dividend of $0.23 per share, and investors expect a 10% return from investing in the company. Calculate the share price if ABC plans to pay a fixed dividend indefinitely. Calculate the share price if ABC’s dividend is expected to grow at a fixed rate of 5% per annum. Between zero growth and constant growth dividend discount model, which one is more suitable for valuing mature companies that have minimal growth opportunities?

Answer 1

- Dividend paid recently (D0)= $0.23 per share

- Required return(Ke) = 10%

i). Calculating the share price if ABC plans to pay a fixed dividend indefinitely:-

Share price = Annual Dividend/Ke

=$0.23/10%

=$2.30

ii). Calculating the share price if ABC’s dividend is expected to grow at a fixed rate of 5% per annum:-

Share price = Annual Dividend(1+ Growth rate)/Ke

=$0.23(1+0.05)/10%

=$2.415

iii). While mature Companies have minimal growth opportunities they uses constant growth dividend discount model to value there companies.

As, mature company have minimal growth opportunities but they don't have zero growth. Mature companies growth pace declines usually but it does not reach to Zero growth.

Thus, they uses constant growth dividend discount model.