Question

Find a fair stock price if the current dividend is $4.00 per share, required return on equity is 12% and growth rate in future dividends is 3.5%.

Answer 1

Solution :

As per the Gordon growth Model the Fair stock price of a stock is calculated using the following formula:

P0 = D0 * [ ( 1 + g ) ] / ( ke – g )

Where

P0 = Fair stock Price   ; D0 = Current dividend ;     g = growth rate in future dividends ;

ke = Required return on equity ;

As per the information given in the question we have ;

D0 = $ 4.00 ;       g = 3.5 % = 0.035 ;    ke = 12 % = 0.12

Applying the above values in the formula we have

= [ 4 * ( 1 + 0.035 ) ] / ( 0.12 – 0.035)

= ( 4 * 1.035 ) / ( 0.12 – 0.035)

= ( 4 * 1.035 ) / 0.085

= 4.1400 / 0.085

= $ 48.705882

= $ 48.71 ( when rounded off to two decimal places )

Thus the fair stock price = $ 48.71