Question

Assume that Coca-Cola Company has a share price of $42.41. The firm will pay a dividend of $1.18 in one year, and you expect Coca Cola to raise this dividend by approximately 6.5% per year in perpetuity a. If Coca-Cola's equity cost of capital is 8.1%, what share price would you expect based on your estimate of the dividend growth rate?

Answer 1

Using the Gordon Growth Model with a dividend of $1.18, an equity cost of capital of 8.1%, and a growth rate of 6.5%, the expected share price for Coca-Cola would be $73.75.

Step-by-step explanation:

The expected share price based on the dividend growth rate can be calculated using the Gordon Growth Model (GGM). The formula for GGM is P0 = D1 / (k - g), where P0 is the current stock price, D1 is the expected dividend in one year, k is the cost of equity capital, and g is the growth rate of dividends.

Given the values: D1 = $1.18, k = 8.1%, and g = 6.5%, we can calculate the expected share price:

• Substitute the given values into the formula: P0 = $1.18 / (0.081 - 0.065).
• Calculate the denominator: 0.081 - 0.065 = 0.016.
• Calculate P0: P0 = $1.18 / 0.016 = $73.75.

Therefore, based on a dividend growth rate of 6.5% and an equity cost of capital of 8.1%, the expected share price for Coca-Cola would be $73.75.