Question

Michael's, Inc., just paid $2.20 to its shareholders as the annual dividend. Simultaneously, the company announced that future dividends will be increasing by 4.8 percent. If you require a rate of return of 9 percent, how much are you willing to pay today to purchase one share of the company's stock?

Answer 1

Answer:

The maximum price that should be paid for one share of the company today is $54.895

Explanation:

The price of a stock that pays a dividend that grows at a constant rate forever can be calculated using the constant growth model of Dividend discount model (DDM) approach. The DDM values a stock based on the present value of the expected future dividends. The formula for price today under this model is,

P0 = D1 / r - g

Where,

• D1 is the expected dividend for the next period or D0 * (1+g)

• r is the required rate of return

• g is the growth rate in dividends

SO, the maximum that should be paid for this stock today is:

P0 = 2.2 * (1 + 0.048)  /  (0.09 - 0.048)

P0 = $54.895 rounded off to $54.90