Question

A stock is expected to pay a dividend of $0.50 at the end of the year (i.e., D1 = $0.50), and it should continue to grow at a constant rate of 9% a year. If its required return is 12%, what is the stock's expected price 1 years from today? Round your answer to two decimal places. Do not round your intermediate calculations.

Answer 1

Answer:

P1 = $18.16667 rounded off to $18.17

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 = D1 / (r - g)

Where,

• D1 is dividend expected for the next period /year

• g is the growth rate

• r is the required rate of return or cost of equity

To calculate the price of the stock today (P0), we use the dividend expected for the next period (D1). Similarly, to calculate the price of the stock one year from today (P1), we will use D2.

P1 = 0.5 * (1+0.09)  /  (0.12 - 0.09)

P1 = $18.16667 rounded off to $18.17