Question

A firm expects to pay dividends at the end of each of the next four years of $2.00, $1.50, $2.50, and $3.50. If growth is then expected to level off at 8 percent, and if you require a 14 percent rate of return, how much should you be willing to pay for this stock

Answer 1

P0 = $43.96935449 rounded off to $43.97

Step-by-step explanation:

Using the dividend discount model, we can calculate the price of the stock today. The DDM values a stock based on the present value of the expected future dividends from the stock. The formula to calculate the price of the stock today is,

P0 = D1 / (1+r) + D2 / (1+r)^2 + ... + Dn / (1+r)^n + [(Dn * (1+g) / (r - g)) / (1+r)^n]

Where,

• g is the constant growth rate
• r is the required rate of return

P0 = 2 / (1+0.14) + 1.5 / (1+0.14)^2 + 2.5 / (1+0.14)^3 + 3.5 / (1+0.14)^4 +

[(3.5 * (1+0.08) / (0.14 - 0.08)) / (1+0.14)^4]

P0 = $43.96935449 rounded off to $43.97