stock is not expected to pay dividends until three years from now. The dividend is then expected to be $2.00 per share, the dividend payout ratio is expected to be 40%, and the return on equity is expectedto be 15%. If the required rate of return is 12%, the value of the stock today is closest to:

Question

Business

Javion Walter

21 February, 02:53

stock is not expected to pay dividends until three years from now. The dividend is then expected to be $2.00 per share, the dividend payout ratio is expected to be 40%, and the return on equity is expectedto be 15%. If the required rate of return is 12%, the value of the stock today is closest to:

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Answers (1)

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Aylin Preston · Answer 1

The value of the stock today is closest to $53.15

Explanation:

Under the Gordon Growth Model, the share price of share can be calculated as follow

Price of share = D / (k - g)

Where:

D = End of the first period Dividend

k = Required Rate of Return

g = Expected growth rate

g can be calculated as follow

g = Retention Rate x and ROE

g = (1 - Dividend Payout Ratio) x ROE

g = (100% - 40%) x 15% = 60% x 15% = 9%

D = $2

k = 12%

Dividends will start at year 3. This will be after 2 years of the end of the year dividend.

Year 3 share Price = $2 / (12% - 0.09%)

Year 3 share Price = $66.67

Discounting the year 3 share price back to today's value,

Today's share price = Year 3 share Price / (1 + required ROR) ^n

Today's share price = 66.67 / (1 + 12%) ^2

Today's share price = $53.15