Question

Gerold's Travel Service just paid $1.79 to its shareholders as the annual dividend. Simultaneously, the company announced that future dividends will be increasing by 3.2 percent. If you require a 10.5 percent rate of return, how much are you willing to pay to purchase one share of this stock?

Answer 1

The maximum price that will be paid today for this stock is $25.31

Step-by-step explanation:

The price of a stock whose dividends are growing at a constant percentage is calculated using the constant growth model of the DDM. The formula to calculate the price under the constant growth model is,

P0 = D0 * (1+g) / (r - g)

Where,

• D0 * (1+g) is the D1 that is dividend expected for the next period
• r is the required rate of return
• g is the growth rate in dividends

Thus, the maximum price for one share of the stock that will be paid today,

P0 = 1.79 * (1+0.032) / (0.105 - 0.032)

P0 = $25.305 rounded off to $25.31