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13 September, 06:43

What should be the current price of a share of stock if a $5 dividend was just paid, the stock has a required return of 20%, and a constant dividend growth rate of 6%? A. $19.23 B. $25.00 C. $35.71 D. $37.86

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  1. 13 September, 09:10
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    Current Price of the Share Stock is $ 37.86 (D)

    Explanation:

    Using dividend valuation method with a constant growth rate assumption, share price is calculated as : Po = D1 / (Ke-g).

    Where; Po ⇒Market Value excluding any dividend currently payable

    D1 = Do (1+g) ⇒Expected dividend in one year's time

    Ke = Required rate of return by shareholders

    g = Dividend growth rate

    Calculation

    D1 = 5 (1+0.06) = $5.3

    Hence, Po = 5.3 / (0.20-0.06)

    Po=$37.86

    The share price is expected to reflect the future expected stream of income i. e dividends and capital gains, discounted at an appropriate cost of capital.

    Some of the assumptions of dividend valuation method include but not limited to the following:

    - it assumed that investors act rationality and in the same way;

    -the dividend either show growth or no growth;

    -the discount rate used exceeds the dividend growth rate.
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