Question

World-Tour Co. has just now paid a dividend of $2.83 per share (D0); its dividends are expected to grow at a constant rate of 6% per year forever. If the required rate of return on the stock is 16%, what is the current value of the stock, after paying the dividend?

a. rs.30
b. rs.48
c. rs.70
d. rs.56

Answer 1

Using the Gordon Growth Model formula, the current value of the stock after paying a dividend of $2.83 with a growth rate of 6% and a required return of 16% is $30. The correct answer is option a.

Step-by-step explanation:

To determine the current value of a stock after paying the dividend, given the company has just paid a dividend of $2.83 per share (D0) and the dividends are expected to grow at a constant rate of 6% per year indefinitely, we use the Gordon Growth Model (also known as the Dividend Discount Model).

The formula is

P0 = D1 / (k - g),

where P0 is the current stock price, D1 is the expected dividend next year, k is the required rate of return, and g is the dividend growth rate.

In this case, D1 equates to $2.83 * (1 + 0.06) = $3.00.

Given a required rate of return of 16% and a constant growth rate of 6%, the current value of the stock is

P0 = $3.00 / (0.16 - 0.06) = $30.

Therefore, the correct answer is a. rs.30.