Question

Firm A is expected to pay a dividend of $1.30 at the end of the year. The required rate of return is 11%. Other things held constant, what would the stock’s price be if the dividend growth rate is expected to be 6%?

Answer 1

Solution:

Given:

Expected Dividend at the End of Year = $ 1.30

Required Rate of Return or Cost of Equity = 11 %

Dividend Growth Rate = 6 %

To Calculate:

Stock’s Price as per Dividend Growth Rate

Process- Calculations:

Step: Calculation of Stock’s Price:

Formula: According to Dividend Growth Model Stock Price P0 is equal to:

P0= D1 / (Ke – G)

Where:

P0 = Stock Price

D1 = Expected Dividend at the end of the year

Ke = Cost of Equity or Required Rate of Return

G= Growth Rate of Dividend

Here:

D1 = $ 1.30

Ke= 11 %

G = 6 %

On putting these values in the formula, we get,

P0 = $ 1.30 / (11 % - 6 %)

P0 = $ 1.30 / (0.11 – 0.06)

P0 = $ 1.30 / 0.05 = $ 26

Stock’s Price P0 = $ 26

Ans: Stock’s Price as per Dividend Growth Rate is $ 26.