Question

Using a dividend discount model, what is the value of a stock that pays an annual dividend of $5 that is not expected to grow, and the discount rate is 10%? What will be the value of the stock if the dividend is expected to grow 5% per year?

Answer 1

a. Value of the stock without growth rate

= D1 / (r - g)

= $5 / (10% - 0)

= $5 / 10%

= $5 / 0.10

= $50

b. Value of the stock with growth rate

= D1 / (r - g)

= $5 / (10% - 5%)

= $5 / 5%

= $5 / 0.05

= $100