Question

Holtzman Clothiers's stock currently sells for $19.00 a share. It just paid a dividend of $1.00 a share (i.e., D0 = $1.00). The dividend is expected to grow at a constant rate of 9% a year. What stock price is expected 1 year from now? Round your answer to the nearest cent. $ What is the required rate of return? Do not round intermediate calculations. Round your answer to two decimal places. %

Answer 1

The price of the stock one year from now will be $20.71

Step-by-step explanation:

Using the constant growth model of Dividend Discount Model, we can calculate the price of a share that grows at a constant rate. The formula for price today under constant growth model is,

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

Using the available values for price, D0 and g, we can calculate the required rate of return.

19 = 1 * (1+0.09) / (r - 0.09)

19 * (r - 0.09) = 1.09

19r - 1.71 = 1.09

19r = 1.09 + 1.71

r = 2.8 / 19

r = 0.1473684211 or 14.73684211% rounded off to 14.74%

To calculate the stock price today using this model, we use D1 or dividend for the next period. To calculate the price one year from now, we will use D2.

P1 = 1.09 * (1+0.09) / (0.1473684211 - 0.09)

P1 = $20.71