Common stock value problems
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A company will pay a dividend of $1.50 per share in the next 12 months (D1). The required rate of return (Ke) is 10% and the constant growth rate is 5%.
a. Compute P0.
(For parts b, c, and d in this problem all variables remain the same except the one specifically changed. Each question is independent of the others.)
b. Assume Ke, the required rate of return, goes up to 12%; what will be the new value of P0?
c. Assume the growth rate (g) goes up to 7%; what will be the new value of P0?
d. Assume D1 is $2, what will be the new value of P0?
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Solution Summary
The solution explains how to calculate the value of a stock using the dividend discount model.
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a. Compute P0.
P0 is given as D1/(Ke-g)
Here we are given D1 as 1.50
Ke=10%
g=5%
P0 = 1.50/(10%-5%) = $30
This gives us the price of a stock today which pays a dividend of $1.50 and the dividends grow at 5% each year. The required return by the investor is ...
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