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Stock Valuation

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?

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 ...

Solution Summary

The solution explains how to calculate the price of stock using the dividend discount model.

$2.19