Question

Based on the historical performance of Strava Corporation, you expect earnings and dividends to grow at a constant rate of 9%. You are considering buying this stock at its current market price of $60. Based on a beta of 1.2, you would require a return of 14% on this stock. The stock just paid a dividend of $4 based on recent accounting statements. How much should you pay for this stock?

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 = 14% and g is the growth = 9%

First we will calculate next years' dividend. Dividend will grow at the rate of 9% 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 = $4, r is the rate of interest = 9% and n is 1 years

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

FV = $4 * (1 + 9%)1

FV = $4 * (1 + 0.09)

FV = $4 * 1.09

FV = $4.36

So, value of D1 is $4.36

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

Share price = $4.36 / 14% - 9%

Share price = $4.36 / 5%

Share price = $87.2

So, based on recent accounting statements, value of share is $87.2.