Question

MasksAreUs Inc. just paid a dividend of $3 per share. Future dividends are expected to grow at a constant rate of 5% per year. What is the value of the stock if the required return is 8%?

Answer 1

As per Gordon model, share price is given by:

Share price = D1 / k -g

where, D1 is next years' dividend, k is the required rate of return = 8% and g is the growth = 5%

First we will calculate next years' dividend. Dividend will grow at the rate of 5% annually. So we will calculate the D1 by future value formula as per below:

FV = P * (1 + r)¹⁰

where, FV = Future value, which is the dividend next year,  P is current years' dividend = $3, r is the rate of interest = 5% and n is 1 years

Now, putting these values in the above formula, we get,

FV = $3 * (1 + 5%)¹

FV = $3 * (1 + 0.05)

FV = $3 * 1.05

FV = $3.15

So, value of D1 is $3.15

Now, we will calculate the share price by putting the values in the Gordon Model formula:

Share price = $3.15 / 8% - 5%

Share price = $3.15 / 3%

Share price = $105