Question

After one year, a company will pay $20 in dividends. It commits to paying $21 two years from the current date. This growth rate in dividends is expected to continue indefinitely. The interest rate is 8%.

Required:
1. Compute the current price of this stock, using the dividend-discount model.

Answer 1

Current share price =$361.59

Step-by-step explanation:

According to the dividend valuation, the value of a stock is the present value of expected future dividends discounted at the required rate of return.

The current share price is determined as follows:

P = D(1+g)/Ke-g

p- price of stock - ?

Ke= interest rate - 8%

d - current dividend,

g- growth rate - ?

The growth rate is computed as follows:

The growth rate = (√Dividend in year 2/Current dividend - 1) × 100

Growth rate =(√21/20 - 1 ) × 100 = 2.46 %

P = $20 /0.08- 0.0246

P = $361.59

Current share price =$361.59

Answer 2

$666.67

Step-by-step explanation:

Annual Dividend (D1)= $ 20

Annual Dividend (D2)= $ 21

Growth (g) = {($ 21 - $ 20)/$ 20} x 100

= 5.00%

Interest Rate (ke)= 8.00%

Price (P0) D1/(ke-g)

= $ 20 /(8%-5%)

= $666.67