Question

Investors expect that Amalgamated Aircraft Parts, Inc. will pay a dividend of $2.50 in the coming year. Investors requirea 12% rate of return on the company's shares and they expect dividends to grow at 7% per year. Using the dividend valuation model, find the intrinsic value of the company's common shares.

Answer 1

Answer:

$50

Explanation:

Dividend discount model (DDM) is used to calculate intrinsic value of a stock. Since the dividends are expected to grow indefinitely, the formula will be as follows;

Price (P0) = D1 / (r-g)

where D1 = Next year's dividend = 2.50

r = required rate of return = 12% or 0.12 as a decimal

g = dividend growth rate = 7%

Price (P0) = 2.50/(0.12-0.07)

P0 = 2.50 /0.05

P0 = $50