Question

Assume XYZ Corp.'s dividend payment will be $2.85 one year from now, $4.12 two years from now, and $3.75 three years from now. Further assume that after these three years, the dividend will grow by 5.4% each year. If the required rate of return for the industry XYZ Corp. belongs to is 10.6%, what is the market value of XYZ Corp.'s stock under the Dividend Discount Model?

a)$62.73
b)$64.90
c)$65.75
d)$64.33

Answer 1

The market value of XYZ Corp.'s stock can be determined using the Dividend Discount Model, incorporating the present discounted value of specific dividends and the Gordon Growth Model for the perpetuity value after the initial period.

Step-by-step explanation:

The market value of XYZ Corp.'s stock under the Dividend Discount Model (DDM) can be calculated by using the present discounted value (PDV) of the expected dividend payments and the perpetuity formula for dividends expected to grow at a constant rate. The PDV of the first three dividends, which are $2.85, $4.12, and $3.75 at years 1, 2, and 3, is calculated by discounting them with the required rate of return of 10.6%.

The formula for the PDV of a future payment is PDV = Payment / (1 + rate of return)^number of years. The perpetuity value starting from year 3, with a growth rate of 5.4%, is calculated using the Gordon Growth Model formula: P = D / (r - g), where P is the stock price, D is the dividend payment, r is the required rate of return, and g is the growth rate. Once the PDV of the expected dividends and the perpetuity after three years are calculated separately, they are summed to obtain the total PDV of the stock, from which we can get the current market value of the stock. To find the price per share, divide the PDV of total profits by the number of shares.