Question

Fake Company Lambda just paid a large dividend to common shareholders of $1.69. Company executives also announced a plan to keep the dividend growing at 2.4% for the foreseeable future. If your required return on equity investments is 6.3%, what is an appropriate price for you to pay for this stock?

Answer 1

Using the Gordon Growth Model, the appropriate price for a stock from Fake Company Lambda with a dividend of $1.69 growing at a rate of 2.4% and a required return of 6.3% is $43.33.

Step-by-step explanation:

To find an appropriate price to pay for the stock of Fake Company Lambda, we can use the Gordon Growth Model (also known as the Dividend Discount Model). This model takes into account the most recent dividend payment, the growth rate of dividends, and the required rate of return to calculate the present value of the expected future dividends which, theoretically, equates to the stock's price.

The formula for the Gordon Growth Model is P = D / (k - g), where P is the price of the stock, D is the latest dividend payment, k is the required rate of return, and g is the growth rate of the dividend. Using the information given: D = 1.69, k = 0.063, and g = 0.024, we can calculate:

P = 1.69 / (0.063 - 0.024)
P = 1.69 / 0.039
P = 43.33

Therefore, an appropriate price to pay for this stock, under the given conditions, would be $43.33.