Question

A firm expects to pay dividends at the end of each of the next four years of $2.00, $1.50, $2.50, and $3.50. If growth is then expected to level off at 8 percent, and if you require a 14 percent rate of return, how much should you be willing to pay for this stock

Answer 1

Answer:

P0 = $43.96935449 rounded off to $43.97

Explanation:

Using the 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 to calculate the price of the stock today is,

P0 = D1 / (1+r)  +  D2 / (1+r)^2  +  ...  +  Dn / (1+r)^n  +  [(Dn * (1+g) / (r - g)) / (1+r)^n]

Where,

• g is the constant growth rate
• r is the required rate of return

P0 = 2 / (1+0.14)  +  1.5 / (1+0.14)^2  +  2.5 / (1+0.14)^3  +  3.5 / (1+0.14)^4  +  

[(3.5 * (1+0.08)  /  (0.14 - 0.08)) / (1+0.14)^4]

P0 = $43.96935449 rounded off to $43.97