Question

Hubbard Industries just paid a common dividend, D0, of $1.70. It expects to grow at a constant rate of 3% per year. If investors require a 11% return on equity, what is the current price of Hubbard's common stock? Round your answer to the nearest cent. Do not round intermediate calculations.

Answer 1

Solution :

Current price of common stock as per Constant Dividend Growth model:

As per the Dividend growth model price of a stock/share = [D₀ * (1 + g)] / (K_e – g)]

Where D₀ = Annual dividend per share

g = Growth rate

K_e = Cost of Equity / Required rate of return on equity

As per the Information given in the question:

D₀ = $ 1.70 ; g= 3 % ; K_e = 11 %

Applying the above values in the formula for price of a stock as per the Dividend Growth model we have:

Price of stock = 1.70 * ( 1 + 0.03 ) / (0.11 – 0.03)

= 1.70 * (1.03) / (0.11 – 0.08)

= 1.751 / (0.11 – 0.08)

= 58.3667 = $ 58.37 (when rounded off to two decimals) = $ 58.4 (when rounded off to 1 decimal place)

Thus, the current price of Hubbard’s common stock as per Dividend growth model = $ 58.4 = 58 dollars and 40 cents.