Question

you are considering investing in General Motors. Based on your research you've gathered the following information: - Beta: 0.96 - Risk-Free Rate: 1.02% - Market Risk Premium: 5.87% - Next Year's Dividend: $2.14 You also don't expect General Motor's dividend to change going forward. Under the DDM, what is the most you should be willing to pay for a share of General Motors?

Answer 1

Using the Dividend Discount Model (DDM) and the provided information, the maximum price you should pay for a share of General Motors is approximately $32.18.

Step-by-step explanation:

You are considering investing in General Motors and want to use the Dividend Discount Model (DDM) to calculate the maximum price you should pay for a share. Given a beta of 0.96, a risk-free rate of 1.02%, and a market risk premium of 5.87%, we can first calculate the required rate of return using the Capital Asset Pricing Model (CAPM). The formula is as follows: Required Rate of Return = Risk-Free Rate + (Beta × Market Risk Premium). Substituting with the values provided:

Required Rate of Return = 1.02% + (0.96 × 5.87%) = 1.02% + 5.63% = 6.65%.

Since you expect that General Motor's dividend will not change, we can use the perpetuity formula of the DDM where Dividend Perpetuity = Dividend / Required Rate of Return. Plugging in the values:

Dividend Perpetuity = $2.14 / 6.65% = $32.18 (approximately).

Therefore, based on the DDM, the most you should be willing to pay for a share of General Motors is approximately $32.18.