A firm will pay a dividend of $2.09 next year. The dividend is expected to grow at a constant rate of 2.37% forever and the required rate of return is 12.16%. What is the value of the stock?

Answer 1

To calculate the value of the stock using the Gordon Growth Model (also known as the Dividend Discount Model), we can use the formula:

\[ P_0 = \frac{D_1}{r - g} \]

Where:

• \( P_0 \) = price of the stock today
• \( D_1 \) = dividend next year ($2.09)
• \( r \) = required rate of return (12.16% or 0.1216)
• \( g \) = growth rate of the dividend (2.37% or 0.0237)

Now, substitute the values into the formula:

\[ P_0 = \frac{2.09}{0.1216 - 0.0237} \]

Calculating the denominator:

\[ 0.1216 - 0.0237 = 0.0979 \]

Now we calculate \( P_0 \):

\[ P_0 = \frac{2.09}{0.0979} \approx 21.35 \]

Thus, the value of the stock is approximately $21.35.