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    Price and dividend of a stock: calculate expected dividend and price

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    You are evaluating the price of a firm's stock. Yesterday, the firm paid $1 a share dividend. You expect the firms earnings and its dividend to grow 5% annual rate. The risk free rate of interest is 2%. The required rate of return for this firm's stock is 9%.

    What do you expect the dividend to equal in three years?

    What would be the most you would pay for this stock if you planned to hold it for 3 years? What about holding it for ten years?

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    Solution Preview

    See attached Excel.

    Do = 1,
    g = 5%
    Rf = 2%
    Rr = 9%

    dividend in three years will grow to:
    D3 = Do * (1+g)^3 = 1 * (1+5%)^3 = $1.16

    If the stock is held for 3 years, we should use the DDM model.
    The dividend at the end of 4 years is
    D4 = ...

    Solution Summary

    The solution shows all the calculations needed to understand and arrive at the correct responses for dividend and price of a firm's stock.