Corporation A has grown at a rate of 5% per year and is expected to continue in that way...

Question:

Corporation A has grown at a rate of 5% per year and is expected to continue in that way indefinitely. The next dividend is expected to be $6 per share.

If the market expects a 15% rate of return on Corporation A, at what price must it be selling? (In other words, what is its current selling price?)

Stock Valuation:

One of the most widely-used stock valuation models is the dividend growth model. The model uses the future dividends to calculate the value of the stock by discounting them back to the present.

Answer and Explanation:


The current selling price is $60.00


The value of the stock can be calculated as:

{eq}Price = \dfrac{D_{1}}{r-g} {/eq}

Here:

  • D1 is the next dividend = $6.00
  • r is the expected return = 15% or 0.15
  • g is the dividend growth rate = 5.0% or 0.05
  • Price is the current selling price

Using the aforementioned values into the formula we have:

{eq}Price = \dfrac{ $ 6.00 }{0.15-0.05} {/eq}

{eq}Price = $60.00 {/eq}


Learn more about this topic:

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The Dividend Growth Model

from Finance 101: Principles of Finance

Chapter 14 / Lesson 3
9.7K

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