Question

The Brown Company just announced that they will be increasing their annual dividend to $1.68 next year and that future dividends will be increased by 2.5% annually. How much would you be willing to pay for one share of the Brown Company stock if you require a 12% rate of return?

Answer 1

Answer:

Current price of Brown Company = $17.68

Explanation:

Using dividend growth model we have

$P_0 = \frac{D_1}{K_e\: -\: g}$

Where,$P_0$ = Current price of share

$D_1$ = Dividend to be paid at year end = $1.68 as provided,

$K_e$ = Cost of equity or expected return on equity = 12% as provided,

g = growth rate = 2.5% as provided,

Now putting the values in above we have

$P_0 = \frac{1.68}{0.12 - 0.025}$

$P_0 = \frac{1.68}{0.095}$

$P_0 = 17.68$

Current price of Brown Company = $17.68

This is the price every person would be willing to pay at current level.