Question

"Kandle Company paid a dividend of $4.76 per share this year and plans to pay a dividend of $5 per share next year, which is expected to increase by 3 percent per year subsequently. The required rate of return is 15 percent. The value of Kandle stock, according to the dividend discount model, is $____."

Answer 1

The price of the stock is $41.67

Step-by-step explanation:

The dividend discount model (DDM) is a model used to calculate the fair price of a stock based on the present value of the expected future dividends from the stock. For a stock whose dividends are expected to grow at a constant rate, we use the constant growth model of DDM.

The formula for price under this model is,

Price = D1 / (r - g)

Where,

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

As, the constant growth in dividends start from Year 2, we will calculate the price of the at Year 1 using the constant growth model and D2 and add the D1 to the stock price in Year 1 and discount it using the required rate of return.

Price = D1 / (1+r) + [ (D2/ r - g) / (1+r) ]

Price = 5 / (1+0.15) + [ (5 * (1+0.03) / (0.15 - 0.03)) / (1+0.15) ]

Price = 41.67