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31 August, 04:00

S&P Enterprises will pay an annual dividend of $2.08 a share on its common stock next year. The firm just paid a dividend of $2.00 a share and adheres to a constant rate of growth dividend policy. What will one share of S&P common stock be worth ten years from now if the applicable discount rate is 8 percent?

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  1. 31 August, 05:18
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    The price of the stock will be $76.97

    Explanation:

    We first need to determine the constant growth rate on dividends.

    Growth rate (g) = (D1 - D0) / D0

    Growth rate (g) = (2.08 - 2.00) / 2 = 0.04 or 4%

    To calculate the price of a stock today whose dividends are growing at a constant rate, we use the constant growth model of DDM. The price of the stock today under this model is,

    P0 = D1 / (r - g)

    Where,

    D1 is the dividend expected for the next year r is the required rate of return g is the growth rate

    Thus, to calculate the price of the stock today at t=10, we will use the dividend expected in Year 11 or D11.

    D11 = D0 * (1+g) ^11

    Where P10 is the price 10 years from today.

    P10 = 2 * (1+0.04) ^11 / (0.08 - 0.04)

    P10 = $76.97
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