Question

Constant growth valuation

Holtzman Clothiers' stock currently sells for $15 a share. It just paid a dividend of $2.25 a share (i.e., D₀ = $2.25). The dividend is expected to grow at a constant rate of 4% a year.

1. What stock price is expected 1 year from now? Round your answer to two decimal places.
   $   
   
2. What is the required rate of return? Round your answers to two decimal places. Do not round your intermediate calculations.
   %

Answer 1

Information provided:

Current stock price= $15

Current dividend= $2.25

Dividend growth rate= 4%

The question is solved using the dividend discount model.

a.Price of the stock expected 1 year from now= $15*(1+ 0.04)

= $15.60

b.The stock’s required rate of return is calculated using the below formula:

Ke=D1/Po+g

Where:

D1= Next year’s dividend

Po=Current stock price

g=Firm’s growth rate

Ke= $2.25*(1+ 0.04)/ $15 + 0.04

     = $2.34/ $15 + 0.04

     = 0.1560 + 0.04

     = 0.1960*100

     = 19.60%.

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