Question

The Whirlwind Co. just paid an annual dividend of $3 a share. The firm expects to pay dividends forever and to increase the dividend by 5 percent annually. What is the current value of this stock if the required return is 9 percent?

Answer 1

Stock price is $78.75

Step-by-step explanation:

The formula for computing the stock price is given below:

stock price=Do*(1+g)/r-g

Do is the dividend that has just been paid at $3

g is the dividend growth rate at 5%

rate of return r is the expected return on the share at 9%

stock price=$3*(1+5%)/(9%-5%)

=$78.75

A rational investor would only pay $78.75 for the stock of the company considering the fact that the dividend grows at 5% per year and the return on stock is 9%

Answer 2

The current value of the stock is $78.75

Step-by-step explanation:

The constant growth model of DDM will be used to calculate the price of the stock as its dividends are expected to grow at a constant rate forever. The formula for price under this model is,

P0 = D1 / r - g

Where,

• D1 is the dividend expected for the next period
• r is the required rate of return
• g is the growth rate in dividends

P0 = 3 * (1+0.05) / (0.09 - 0.05)

P0 = $78.75