Question

Given a current dividend of $4.00 (just paid), a required rate of return of 8% and a dividend growth rate (g) of 2% for 10 years, compute the current value of the stock.

Answer 1

Solution:

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

P = D₀ * [ ( 1 + g ) ] / ( k_e – g )

Where

P = Price of the share;      D₀ = Recent dividend paid ; g = growth rate ;

k_e = Required Rate of return

As per the information given in the question we have ;

D₀ = $ 4.00   ;       g = 2 % = 0.02 ;    k_e = 8 % = 0.08

Applying the above values in the formula we have

= [ 4 * ( 1 + 0.02 ) ] / ( 0.08 – 0.02)

= ( 4 * 1.02) / 0.06

= 4.08 / 0.06 = 68

= $ 68 per share

Thus the current value of stock = $ 68