Stock Valuation
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P0 = Price of the stock today
D1 = Dividend at the end of the first year
D0 = (1 _ g)
D0 = Dividend today
Ke = Required rate of return
g =Constant growth rate in dividend
D0 is currently $3.00, Ke is 10 percent, and g is 5 percent
Under Plan A, D0 would be immediately increased to $3.40 and Ke and g will
remain unchanged.
Under Plan B, D0 will remain at $3.00 but g will go up to 6 percent and Ke
will remain unchanged.
a. Compute P0 (price of the stock today) under Plan A. Note D1 will be equal
to D0 * (1 + g) or $3.40 (1.05). Ke will equal 10 percent and g will equal 5
percent.
b. Compute P0 (price of the stock today) under Plan B. Note D1 will be equal
to D0 * (1 + g) or $3.00 (1.06). Ke will be equal to 10 percent and g will
be equal to 6 percent.
c. Which plan will produce the higher value?
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Solution Summary
The solution explains how to calculate the price of stock using the dividend discount model.
Solution Preview
a. Compute P0 (price of the stock today) under Plan A. Note D1 will be equal
to D0 * (1 + g) or $3.40 (1.05). Ke will equal 10 percent and g will ...
Purchase this Solution
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