Question

Financial analysts forecast Safeco Corp.’s (SAF) growth rate for the future to be 8 percent. Safeco’s...

Financial analysts forecast Safeco Corp.’s (SAF) growth rate for the future to be 8 percent. Safeco’s recent dividend was $1.25. What is the value of Safeco stock when the required return is 10 percent? (Round your answer to 2 decimal places.)

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Answer #1

This question is based on the concept of Constant Growth Dividend Discount Model.

As per Constant Growth Dividend Discount Model the dividends will grow at a constant rate forever.

We will use the formula - Value of stock = D1 / (Re - g)

Where D1 is the dividend for year 1

Re is required rate of return

g is growth rate

Note - In the question it states Safeco Corp's recent dividend was $1.25. This is D0 or Current Dividend.

D1 = D0 * (1 + growth rate)

D1 = $1.25 * (1 + 0.08)

D1 = $1.25 * 1.08

D1 = $1.35

Calculation of value of stock

Value of stock = D1 / (Re - g)

Value of stock = $1.35 / (0.10 – 0.08)

Value of stock = $1.35 / 0.02

Value of stock = $67.50

The value of Safeco stock is $67.50.

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