Question

D0 is currently $3.00, Ke is 8 percent, and g is 5 percent. Under Plan A, D0 would be immediately increased to $3.40 and Ke and g will remain unchanged. Under Plan B, D0 will remain at $3.00 but g will go up to 6 percent and Ke will remain unchanged. a. Compute P0 (price of the stock today) under Plan A. Note D1 will be equal to D0 × (1 + g) or $3.40 (1.05). Ke will equal 8 percent, and g will equal 5 percent. (Round your intermediate calculations and final answer to 2 decimal places.)

Answer 1

Answer:

a.

P0 = 3.4 * (1+0.05)  /  (0.08 - 0.05)

P0 = $119

Explanation:

Using the constant growth model of dividend discount model, we can calculate the price of the stock today. The DDM values a stock based on the present value of the expected future dividends from the stock. The formula for price today under this model is,

P0 = D0 * (1+g) / (r - g)

Where,

• Do is dividend today

• g is the growth rate

• r is the required rate of return

a.

P0 = 3.4 * (1+0.05)  /  (0.08 - 0.05)

P0 = $119